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194. Memorandum From the U.S. Executive Director, International Monetary Fund (Cross) to the Under Secretary of the Treasury for Monetary Affairs (Solomon) and Members of the International Monetary Group1


  • IMF Consideration of Substitution Account


In recent months there has been a renewal of interest in the possibility of establishing a substitution account for shifting official dollar claims to official SDR claims.2 In the IMF, the Interim Committee communique last fall stated that this matter would be “kept under review,”3 and some Executive Directors have recently proposed that the Board consider it promptly. In the Congress, Reuss and Javits have urged that such an account be established.

The U.S. has made clear that we have an open mind about ideas for evolution of the system; that we have no interest in preserving an artificial role for the dollar and are prepared to contemplate a reduction in its relative role; and that in considering substitution proposals our objective will be not to resist change but to ensure that any change will be an improvement from our own point of view and that of an open and stable system.

The substitution issue is on the agenda of the next Interim Committee meeting (March 7), and the IMF staff has prepared the attached paper for Board discussion February 12.4 It argues the case for substitution on grounds that:

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—it would represent an evolutionary move to strengthen the system and enhance the position of the SDR;

—without it there is a risk of continuing instability as governments seek to diversify reserves;

—the time to act is now, since the November 1 measures have stabilized markets and fundamentals are improving.

Three types of substitution are mentioned in the IMF staff paper. Some comments on each type follow.

Type A—SDR-Denominated Claims Issued by the United States

1. This is basically a guarantee scheme, not necessarily involving any permanent substitution of SDRs for dollars, increasing the use of SDR more as a unit of account than as an asset. (The claims issued by the U.S. would be very similar to SDRs, without the Fund-related provisions for designation, acceptance limits, guaranteed usability at “equal value” exchange rate, etc. However, if and when the account were liquidated, the U.S. obligation would presumably be to pay not SDRs but whatever number of dollars is called for under the SDR guarantee.

2. The exchange risk, and attendant possible gains or losses, is borne entirely by the United States. The IMF paper rather passes this off, saying the risk is less than what U.S. has taken on by DM and Swiss franc borrowing, which ignores the fact that we borrowed to accumulate resources for market operations rather than to mop up dollars.

3. U.S. legal and financial considerations need to be explored to determine possibilities for carrying exchange risk. We think it is probably legal for ESF to carry risk, but its resources are woefully inadequate. The General Account can borrow in foreign currencies, but there may be problems in its borrowing (and repaying) in dollars with foreign currency or SDR guarantee. We are researching this question.

4. Characteristics of the Type A “guarantee” proposal make it look more like a dollar support exercise, and less like a long-term evolution of the system toward the SDR.

5. There could be an incentive for long-term deposits (beyond 10 years), raising questions about our debt management policies and the ceiling on long-term issues by the Treasury. Similar questions would arise under Types B and C.

Type B—Allocation of SDRs by the Fund

1. Similar to Witteveen’s proposal last year for an SDR allocation tied to equivalent deposit of dollars by each participant. This time IMF staff says “U.S. could use its SDR allocation to buy dollars from those countries prepared to absorb additional dollars,” presumably in response to earlier criticisms that the U.S. was not paying out any “assets” under the Witteveen scheme. The staff paper also says that since SDR allocations must be proportional to quotas, this approach [Page 576]“would involve heavy reliance on a mechanism through which many countries would sell their newly allocated SDRs for dollars to a few countries.”

2. Proposal was discussed in IMF Board last year, before allocations for 1979–81 were agreed. Several (especially U.K. and Belgium) were in favor, some with comment that U.S. should participate by paying gold or other assets. Some were opposed such as Germans who feared vicious cycle of substitution leading to more dollars leading to more substitution; and Italians, who wanted straight SDR allocation and felt that proposal would provide no future control over international liquidity. Many took no definite position but saw both pros and cons in the idea.

3. Type B provides the clearest and most immediate substitution of the three varieties.

Type C—SDR-Denominated Claims Issued Through an Account Administered by the Fund

1. This is the most novel approach. While no details are provided, one can envisage an account in which—at least at present interest rates—dollars deposited long term and earning say, 9 percent, could be used to pay SDR interest of, say, 6 percent and accumulate the difference for meeting the exchange risk.

2. If the U.S. were to pay interest to the account on the dollar deposits in the form of SDR, at least when it had SDRs, and the account were to pay out interest in the form of dollars, the account would gradually be transformed from dollars to SDRs.

3. Thus a form of Type C could be envisaged under which there would be a partial SDR guarantee, to the extent funds were available from the interest rate differential. The only U.S. obligation would be a claim against our future SDR earnings and allocations.

Questions for IMG

1. Would a move toward official substitution benefit the dollar in terms of short-term market psychology? If so, is one of the three approaches (or some alternative approach) preferable to the others?

2. Does it make sense to introduce schemes for official substitution without action on private international use of the dollar, or future official accumulations?

3. From the point of view of the U.S. long-term interest in a smoothly functioning international monetary system, and assuming substitution can be introduced without other major changes in the system, is substitution in the U.S. interest and worth the financial costs? I.e., is it the best use of U.S. resources in terms of exchange rate guarantees or giving up claims to future SDR allocations or earnings?

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4. What are the prospects of negotiating substitution without other major changes in the international monetary system (most importantly, toward asset settlement and central control of international liquidity)? Would such changes be in the U.S. interest? In assessing this question is there a distinction to be made between movement toward such a system in the long run vs. the short run?

  1. Source: National Archives, RG 59, Office of the Under Secretary for Economic Affairs, 1978–1980 Files Pertaining to International Monetary Affairs, OECD, Documents, External Research, Etc., Lot 81D145, Box 2, IMG—International Monetary Group. Confidential.
  2. According to the official IMF history for the years 1979–1989, dollar depreciation in both late 1977 and late 1978 stimulated interest in the creation of a substitution account. (Boughton, Silent Revolution, pp. 937 and 939)
  3. The text of the Interim Committee communiqué, dated September 24, 1978, is printed in de Vries, The International Monetary Fund, 1972–1978: Cooperation on Trial, vol. III, Documents, pp. 239–242.
  4. Not attached. The IMF staff paper SM/79/30, January 29, from the Acting Secretary to Members of the Executive Board on “Review of the Question of a Substitution Account, and Related Issues” is in the National Archives, RG 59, Office of the Under Secretary for Economic Affairs, 1978–1980 Files Pertaining to International Monetary Affairs, OECD, Documents, External Research, Etc., Lot 81D145, Box 2, IMG—International Monetary Group.