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126. Briefing Memorandum From the Under Secretary of the Treasury for Monetary Affairs (Solomon) to Secretary of the Treasury Blumenthal 1


  • Supplemental Briefing for Fowler Committee Meeting April 13—Witteveen’s Proposal for a “Substitution Account”

This proposal (described in Tabs D and F of your Fowler Committee briefing)2 may become a focus of both the Fowler Committee and Interim Committee discussions. It has potentially wide implications, and we need to take a very careful approach.

In the C–20 reform negotiations,3 there were extended discussions of proposals for substitution of SDRs for foreign official holdings of dollars, in the framework of a resumed system of par values and convertibility of currencies into “primary” reserve assets (SDR and gold). The idea was to establish a new account in the IMF that would buy dollars from official holders with newly created SDR, and hold the resulting claims on the U.S. The par value reform approach was dropped, and serious negotiations on terms of a substitution account never materialized. But it was widely assumed (hoped) by others that the U.S. would bear exchange risk and pay market rates of interest on substituted dollars, and would undertake some form of amortization obligation.

Witteveen’s proposal is supposedly much more modest, and is not cast in terms of reform of the system. He has been trying to develop support for an SDR allocation, but has run into strong German and other European objections on grounds that additional international liquidity is not needed. He has hit on this scheme as a way of getting his SDR allocation and meeting European objections to increased liquidity: at the same time there is an SDR allocation, countries would make irrevocable [Page 381]deposits of foreign exchange (mainly or wholly dollars) in a special account at the IMF. Each country’s deposit would be equal to its allocation or to some agreed fraction of its allocation; the deposit would be illiquid and therefore no longer counted as reserves; and it would earn interest at longer-term rates based on IMF investment of the deposits in Treasury securities. (Although Witteveen’s paper doesn’t say so, he is entertaining an idea proposed by some that the U.S. would be expected to deposit gold.)

The advantages Witteveen claims for this scheme are a) modest movement toward making the SDR the “principal reserve asset in the system” and b) improvement in the “quality” of international liquidity.

There has been only very brief discussion of this proposal in the Executive Board. To generalize:

—A number of the Europeans are reluctant to increase liquidity, but if there has to be an SDR allocation anyway, this would be a way of mitigating the liquidity impact.

—The LDCs want a straightforward SDR allocation, and they do not want the study of a substitution account to delay an allocation. They profess some interest in the Witteveen idea if it is additional to a regular allocation—though they will probably oppose any permanent deposit of dollars as required in Witteveen’s proposal.

—Nearly all are attracted in some degree by the implied reduction in the dollar’s role in the system. This attraction is particularly strong so long as we are not regarded as dealing adequately with our balance of payments situation, and may overwhelm the views of some countries on the narrower question of SDR allocation per se.

As Witteveen has framed it, the proposal avoids some of the objections of some earlier substitution account proposals. He proposes no U.S. assumption of exchange risk or amortization obligations. The U.S. would be regarded as making a “cooperative” gesture, in agreeing both to an allocation and a modest movement of the system away from dollars.

But I am very leery of this proposal.

—Its stabilizing effect would be nil to negligible at best, and possibly adverse depending on the psychological reaction. The reaction could be bad. In any case, we could expect to get little credit for agreeing to it.

—Both the earlier reform discussions and the initial Board discussion of this proposal suggest a very tough negotiation on terms—interest rate, exchange risk, amortization, liquidity of deposits, what the U.S. puts in, etc.—and we, as issuers of dollars, have a fundamentally different position on these questions from the 131 dollar holders we would be negotiating with.

—There are serious legal questions about our authority to make the irrevocable deposits that would be required, whether in gold or [Page 382]dollars, and serious questions of Congressional attitudes regardless of the legal position.

—Finally, there are political overtones and potential systemic implications that we need to test carefully. (For example, some may point to the fact the proposal is receiving serious consideration as evidence that the U.S. has mismanaged its affairs—we may hear some of that in the Fowler Committee.)

Even if we were to decide that Witteveen’s proposal were attractive to the U.S., our best tactical negotiating position might be one of skepticism and reluctance. For the time being certainly, I think we should be skeptical, but willing to look at the proposal and hear the views of others. We should not be in the position of demandeur.

  1. Source: Carter Library, Anthony Solomon Collection, 1977–1980, Chronological File, Box 4, 4/78. Confidential. Drafted by Leddy and reviewed by Cross.
  2. The briefing was not found and no other record of the April 13 Fowler Committee meeting was found.
  3. In July 1972, the IMF Board of Governors established the Committee on Reform of the International Monetary System, also known as the Committee of Twenty or C–20. After 2 years of negotiations, the C–20 approved an Outline of Reform for the international monetary system at a Ministerial meeting held in June 1974 in Washington. For the text of the Outline, as well as the accompanying C–20 final report, see de Vries, The International Monetary Fund, 1972–1978: Cooperation on Trial, vol. III: Documents, pp. 165–196.