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

NAC Files, Lot 60D137

Memorandum by the NAC Staff Committee to the National Advisory Council

secret

[Washington,] April 23, 1948.

NAC Doc. No. 674

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

Problem

The United States Executive Director on the Fund has submitted a memorandum to the Council (NAC Document No. 623)¹ reporting on the use of the Fund’s resources and raising questions about the policy to be pursued in the immediate future. The international economic developments of the past twelve months and the unfavorable outlook for the restoration of general world equilibrium in the near future make necessary a careful re-examination of policy with regard to the use of the Fund’s resources, particularly in the light of the European Recovery Program.

Discussion

I. Character of Transition Period

It has become increasingly clear over the past few months that the post-war transition period during which most of the members of the Fund would be able to attain equilibrium in their balance of payments may be far longer than the three to five years contemplated at the time of the Bretton Woods Conference. A number of the members of the Fund have been unable to provide even the basic essentials necessary for the operation of their economies without substantial assistance from the Western Hemisphere. Even if at the end of the four year ERP program the countries of Western Europe are on a self-sustaining basis, it is unlikely that they will be able to abandon the use of exchange and quantitative trade controls for some time in the future. In the case of China, and certain other countries of Asia, the possibilities for the restoration of equilibrium conditions within the foreseeable future are perhaps even more remote. The Latin American economies may also find it difficult, if not impossible, to abandon controls in the face of large demands for foreign exchange to finance government-sponsored development projects. Altogether, therefore, the restoration of conditions suitable to the normal operations of the Fund as contemplated in the Articles of Agreement appears very unlikely for the next few years.

Implications for the Use of the Fund’s Resources

The basic policy of the Fund in selling currencies, as provided in the Articles of Agreement, is that the Fund should permit its members to draw currently needed foreign exchange to tide them over temporary defiicits in their balance of payments. The Fund’s resources were not to be used to finance relief and reconstruction. No definite maturity was provided for the extension of foreign exchange credits by the Fund but purchasing members are required to repurchase the Fund’s holdings of their own currencies pari passu with an improvement in their gold and foreign exchange reserve position. The Articles also provide for interest charges that increase with the length of time that currency is held by the Fund and they envisage penalty charges by the Fund if repurchase does not occur within a few years. It is clearly implied therefore that the Fund’s resources would be used only in cases where there was a reasonable expectation that the borrowing countries would be able to restore equilibrium in their balance of payments and repay the Fund within a relatively short period of time.

The current international position of most of the Fund’s members raises serious questions as to their eligibility to draw foreign exchange from the Fund. Many countries have fundamental maladjustments in the structure of their balance of payments, especially in relation to the United States, which may very well prove to be chronic and of long duration. Moreover, improvement in their position may result merely in the relaxation of their exchange controls or trade regulations rather than an increase in their monetary reserves to a point where the repurchase obligations become mandatory. Hence these provisions cannot be relied upon to assure the maintenance of the Fund’s holdings of convertible currencies.

There is a very real danger that liberal or semi-automatic use of the Fund’s resources under present conditions may lead to dissipation of the Fund’s gold and dollar resources which will not then be available for use in accordance with the purposes of the Fund as stated in the Articles of Agreement. On the other hand a decision to close the doors of the Fund to any further financial assistance to its members for an indefinite period until the return of general world economic stability and equilibrium would seriously impair the influence of the Fund over the international exchange policies of its members. Both of these extreme positions should be rejected. Under prevailing conditions some moderate use of the Fund’s resources during the transitional period in conformity with the Fund’s Articles, would be desirable so long as it does not involve too rapid exhaustion of the Fund’s dollar assets.

II. Powers of the Fund To Prevent Misuse of its Resources

There is a clear implication in the Articles of Agreement that members which have attained a reasonable degree of economic stability and are in a position to employ the resources of the Fund in a manner consistent with its purposes will have a more or less automatic right to draw on the Fund in time of need. Nevertheless it is equally clear that the Fund was intended to have adequate powers to safeguard its resources from use in a manner which would contravene the provisions and purposes of the Articles of Agreement. The sections of the Articles of Agreement which relate to this matter are, however, not entirely unambiguous. This is largely the result of the fact that they represent compromises between the British concept of an automatic Fund and the United States concept that use of the Fund’s resources should be subject to effective safeguards. In part, the obscurity of the language is deliberate. Consequently the interpretation of these sections of the Articles has been extremely difficult and has given rise to lengthy debates in the Executive Board.

The decisions of the Board with respect to the Fund’s powers to control the use of its resources may be summarized as follows:

(1) Under Article XX, Section 4 (i), “the Fund may postpone exchange transactions with any member if its circumstances are such that, in the opinion of the Fund, they would lead to the use of the resources of the Fund in a manner contrary to the purposes of this Agreement or prejudicial to the Fund or to members.” The Board has ruled that this section may be applied at any time up to the completion of a member’s first exchange transaction with the Fund, but that it may not be used thereafter.

(2) Under Article V, Section 5, the Fund may declare a member ineligible to use the resources of the Fund or limit or impose conditions upon the use of its resources by a member whenever the Fund is of the opinion that the member is using the Fund’s resources in a manner contrary to the purposes of the Agreement. The Board has interpreted “is using” broadly; i.e., that a member is using the resources of the Fund when the member has made a drawing on the Fund and the Fund’s holdings of the member’s currency exceed 75 percent of its quota.

(3) The Fund may challenge the correctness of a declaration by a member under Article V, Section 3(a) (i) on the grounds that the payments for which the Fund’s resources are requested are not “consistent with the provisions of the Agreement”. Thus, if the Fund determines that a particular declaration by a member is incorrect, it may reject the request or accept it subject to conditions. It is the view of the Board, however, that this power should be used sparingly and only when the Fund has good reason to doubt the correctness of the member’s declaration. Use of this section is not regarded by the Board as a general substitute for action under (1) or (2).

These decisions represent a substantial defeat of the concept of automaticity. Together they may be considered to have established reasonably adequate safeguards over the use of the Fund’s resources. It should be noted, however, that it is the practically unanimous view of the Executive Board that in order to exercise these powers consistently with the spirit of the Articles of Agreement, members should as a general rule be notified, in advance of exchange requests, that the Fund does not consider the member in a condition to make proper use of the Fund’s resources. Unless a member has been so notified, it may presume that it is entitled to draw on the Fund. Secondly, a majority of the Board feel that rather than invoke the formal procedures envisaged in Article V, Section 5, for declaring a member ineligible or limiting the use of the Fund’s resources, it is preferable to indicate the Fund’s views informally and to seek an informal understanding with the member that it will not make requests without prior consultation. From the practical point of view, this means that the Board finds completely unacceptable a procedure involving a review, of individual requests for exchange at the time they are made. Instead, the Fund must keep the economic situation of members constantly under review and take the initiative in approaching and warning members. In a sense, this means that the burden of proof is on the Fund to establish that a member is not entitled to draw on the Fund. Experience to date has made it clear that these powers will seldom be exercised except on the initiative and insistence of the United States Executive Director.

III. Application of Policies

A policy for the next year intended to conserve the Fund’s dollar assets mainly for the post-transitional period, when they may be used more effectively to support exchange stability and the elimination of discriminatory exchange practices, may properly give different treatment to the countries participating in ERP and to the other members. In the course of its first year of operations the Fund’s resources were used principally by the participating European countries. While these advances of dollars undoubtedly have served an important function in this critical period, they may be subject to the objection that under XIV, 1, the Fund’s resources are not to be used for relief or reconstruction. The large amount of aid provided by the United States under the ERP, which is directed toward relieving the balance of payments deficit of the ERP countries with the Western Hemisphere, would seem to preclude additional drawings of dollars from the Fund by these countries. There may be exceptional circumstances which would justify the use of the Fund’s resources by these countries, but each case should be regarded as a special case and decided on its own merits.

For members other than the ERP countries the Fund should be prepared to furnish such dollars or other currencies as they need for purposes that are consistent with the objectives of the Fund. However, because of the desirability of conserving the Fund’s dollar assets, the Fund should in general exercise great care to see that the use of its resources by these countries is very clearly for the purpose of meeting temporary disequilibria in accordance with the purposes of the Fund.

It seems desirable, however, that the Fund be lenient in applying this test to drawings by members other than the ERP countries where the amount requested, in combination with all previous drawings by the given country, amounts to 25 per cent or less of the country’s quota. This exception seems necessary as a measure of fairness between one member country and another. During the first year the Fund has been less rigorous in passing upon applications, and has permitted some member countries to make drawings up to 25 per cent of their quotas under circumstances where a rigorous application of the Articles of Agreement might have resulted in the denial of their applications. Hence, it might seem unfair if very rigorous standards were applied to the initial drawings of countries that did not elect to draw during the first year. It is for this reason that there seems justification for giving any member the benefit of reasonable doubt until its aggregate purchases have reached 25 per cent of its quota.

IV. Conclusion

The Staff Committee is of the opinion that it would be desirable in the course of the next year to restrict purchases of dollars from the Fund by the European countries and also by other members to see to it that purchases of currency really serve the objectives of the Fund. The Staff Committee realizes that it is difficult to lay down absolute rules for the guidance of the Executive Director but it also realizes that there is a danger that the Fund’s dollar resources may be substantially diminished during the transitional period with the consequence that it will not have sufficient dollars available to carry out its policies and the United States objectives in this area at the conclusion of the transitional period when these resources could be used most effectively.

V. Recommendation

The following action is submitted for the consideration of the Council:

The National Advisory Council advises the United States Executive Director on the Fund that he should be guided by the principles set forth below in acting on applications of members for the purchase of currency from the Fund or in determination of the Fund policy with respect to the use of its resources by the members.

1. With a view to conserving the resources of the Fund the use of these resources by any member should be subject to close scrutiny to assure that any purchases conform strictly to the tests required by the Articles of Agreement, and that the purchasing member may reasonably be expected to be able to repurchase its currency within a relatively short period of time. With the qualifications set forth below, this should be achieved primarily by resolving doubts and presumptions in favor of the Fund rather than in favor of the member.

In particular the Fund should be satisfied in appropriate cases that the member concerned will:

(a) Adopt appropriate monetary, fiscal and other economic policies necessary for the restoration of internal and international economic stability.

(b) Adjust its exchange rate to a realistic level in consultation with the Fund when the existing exchange rate is imposing an unjustifiable burden upon the balance of payments of the member.

2. Countries participating in the European Recovery Program should not be permitted to purchase dollars from the Fund except under special circumstances. The United States Executive Director need not object to the purchase in moderate amount of currencies other than dollars from the Fund by these countries.

3. In the case of countries other than those participating in the European Recovery Program, a member applying for the purchase of currency should be given the benefit of reasonable doubt if it represents that the funds are needed for current payments in that currency for purposes consistent with the agreement, and if such purchase would not bring its net purchases of currency from the Fund to more than 25 percent of its quota.

4. Under present circumstances it would be unwise for the Fund to rely solely on the repurchase provisions of the Articles of Agreement for repayment. Members asking to draw beyond 25 percent of their quota should therefore be required to demonstrate to the Fund how they expect to be able to repay within a relatively short period of time in the light of their anticipated balance of payments.²

1. Supra.
2. This paper was discussed and its recommendations adopted by the National Advisory Council at its meeting on May 5, 1948 (NAC Minutes, Meeting No. 94, May 5, 1948, Lot 60D137); the decision was recorded as NAC Action No. 249, May 5, 1948. Among those present of the NAC membership at this meeting were Secretary of the Treasury John W. Snyder (in the chair); Willard L. Thorp, Assistant Secretary of State, for Economic Affairs representing the Department of State; William McChesney Martin, Chairman of the Export-Import Bank; Wayne C. Taylor, Economic Cooperation Administration; Andrew N. Overby and George F. Luthrigner, U.S. Executive Director and U.S. Alternate Executive Director, respectively, of the International Monetary Fund; Eugene R. Black, International Bank for Reconstruction and Development; and Frank A. Southard, Jr., Treasury Department.