Foreign Relations of the United States, 1977–1980, Volume III, Foreign Economic Policy

233. Memorandum From Secretary of the Treasury Miller¹

Washington, February 28, 1980

MEMORANDUM FOR

• The Honorable Walter Mondale
• The Honorable Cyrus Vance
• The Honorable Charles Schultze
• The Honorable Stuart Eizenstat
• The Honorable Richard Cooper
• The Honorable Henry Owen
• The Honorable Paul Volcker
• The Honorable Henry Wallich
• The Honorable Lyle Gramley

SUBJECT

• Our Meeting on the Proposed IMF “Substitution Account,” March 4, 1980²

I have requested this meeting because the Substitution Account proposal involves some potentially important obligations as well as benefits for the U.S., and negotiations on the Account are nearing a decision point.³ It will be discussed by finance ministers at a meeting of the IMF’s Interim Committee in late April and, at the request of the French, will also be taken up at the Venice Summit.

Outline of the Proposal

In brief, the Account would accept dollar deposits by foreign central banks and issue, in exchange, claims denominated in Special Drawing Rights (SDRs), which are valued on the basis of a “basket” of 16 currencies. The Account would invest its dollar holdings in interest-earning U.S.G. securities and would pay interest to the holders of the SDR-denominated claims. The claims issued by the Account would be of indefinite maturity, as is the SDR reserve instrument created by the IMF. Initially, the Account might start at $10–20 billion and could rise to $50 billion over 5 years or so.

This scheme presents a number of potential advantages for the United States and other countries:

—The international monetary system is moving in an uncontrolled way from extremely heavy reliance on the dollar toward greater reliance on other major currencies such as the Deutschemark, the Swiss franc and Japanese yen. The process of diversification, if left to itself, can lead to heavy pressures on the dollar at inopportune times and potentially large costs to the U.S. in terms of dollar support. It can also cause serious economic and financial problems for the countries whose currencies are “targets” of diversification, such as Germany.

—While the existence of the Account would not necessarily halt this process, it could provide an attractive and non-disruptive off-market alternative to diversification through the market, and a “safety valve” that could be made available to potential diversifiers in times of market strain.

—From a longer-term perspective, the Account would be supportive of the generally agreed objective of moving away from national currencies and toward the SDR as the principal reserve asset of the international monetary system. If the Account succeeds and the SDR assumes an increasingly important role, the international monetary system as a whole should become more stable through minimization of shifts among various reserve assets.

Main Issues in the Negotiations

The central issues relate to maintaining financial balance in the Account. The Account can experience losses of two kinds: the interest it receives from the U.S. Government on its dollar investments may not be enough to cover the interest it pays on its SDR-denominated liabilities; and it can show a negative “net worth” if the dollar exchange rate declines relative to the SDR. The question is how these losses are to be financed. Although other countries entered the negotiations with the position that the U.S. should bear these costs, it is now generally accepted that the Account is of potential benefit to depositors and the system as a whole as well as to the United States, and that any costs should therefore be shared equitably.

Gold. One approach to financing losses—which is essential if this key issue is to be resolved, and which appears to have the support of the major countries—is use of part of the IMF’s gold holdings. Assuming general agreement to use of some IMF gold, the main question here is whether the gold should be available to finance all losses by the Account, or whether the U.S. should be obligated to make special above-market interest payments to cover part of any interest gap, with the balance of any losses to be financed with IMF gold.

Some countries are interested in minimizing the need for sales of IMF gold, and see special U.S. “extra” interest payments as a way of achieving this objective. Others are less concerned about the modest gold sales that would be needed to cover interest shortfalls than they are about assuring—symbolically, for domestic political reasons—that the U.S. carries a “burden” in connection with the Account’s operations. We have argued that the U.S. cannot agree to such supplementary payments over and above market interest rates; that it is politically impossible for us; that it is unnecessary given the availability of IMF gold; and that it is unrealistic and inappropriate for others to insist on such payments for the sake of imposing a symbolic burden.

There is some concern over presentational aspects of using gold for the substitution account—that it could be interpreted as a step toward “remonetization,” contrary to U.S. policy and interests. It is difficult to see how the gap in negotiating positions can be bridged without some use of IMF gold, but it is at the same time important to minimize such presentational or image problems. We have therefore insisted, and the other major countries have agreed, that there must be some provision for actual sales of gold to meet an interest gap; and that remaining gold held by the Account would not be valued at the market, but would be recorded in ounces as a memorandum item on the Account’s books or valued only at the price necessary to cover any net worth shortfall.

Guarantees. Even if the gold issue can be resolved satisfactorily, gold does not provide the whole answer: it is conceivable that the amounts of IMF gold available to the Account may become insufficient to maintain the Account’s financial position, and participants will insist on a contingency provision to cover this possibility. We have indicated that, although we are not prepared to make supplementary interest payments to the Account, we are prepared to consider sharing (proportion not yet discussed) in financing any negative balance in the Account at the time of a decision to terminate its operations—provided that such a decision requires the joint consent of the U.S. and other participants, i.e., that we have a veto. Under such an arrangement, there would be at least two options in the event IMF gold became insufficient to balance the Account’s financial position: the Account could terminate at that point and redeem its obligations in full without any calls on guarantees; or it could continue operations (creating new SDR claims on itself to cover any current interest shortfall) and balance its accounts through claims on the ultimate guarantees.

Some countries, while indicating there is a need for an ultimate guarantee at liquidation of the Account, have gone further to argue that guarantees should be callable periodically—before liquidation of the Account—to provide for “maintenance of value” on a current basis. This would mean that someone—presumably the U.S. and depositors in some agreed proportion—would have to pay money into the Account each year a shortfall occurred. The U.S. has argued that current maintenance of value is unnecessary, given the permanent/indefinite maturity of the Account’s obligations and operations, and that the ultimate guarantees should suffice to maintain the integrity of the Account. We have also said that there is no realistic prospect that the U.S. would be able to obtain legislative authority to make maintenance-of-value payments on a current basis. It is also doubtful whether other countries would in fact be prepared to make such periodic payments to the Account.

Legislative Implications

Although we cannot determine precise legislative requirements at this point, some form of legislation would probably be necessary under any variant of the Account that could be negotiated.

—Authorization would be required for the U.S. to participate in a joint guarantee to be activated upon termination of the Account. It is also possible, but not certain, that the Congress would require some form of appropriations action, even though a call on the U.S. commitment would be subject to U.S. veto. (If appropriations were required, we would probably have to seek a permanent/indefinite appropriation, since the amount of our obligation would be indefinite.)

—Authorization and appropriations would almost certainly be needed in advance if the U.S. were to assume obligations to make guarantee payments on a current basis.

—Authorization might be required to raise the ceiling on long-term Treasury debt, depending on the exact arrangements negotiated on the Account’s investment of its dollar holdings.

—U.S. payment of special above-market interest rates on the Account’s investments, to cover part of any interest shortfalls, technically would not require legislation, but could trigger Congressional criticism and efforts to curtail the Secretary of the Treasury’s authority to determine interest payable on the public debt. In any event we do not contemplate any such supplementary payments, and have made that position very clear.

Recommendation

I recommend that the U.S. take the following position at the forthcoming meetings:

First, that we are prepared to support establishment of a substitution account if key questions can be resolved satisfactorily.

Second, that we are not prepared to make supplemental, above-market, interest payments to the Account.

Third, that we will support use of a portion of the IMF’s gold to meet financial imbalances in the Account, whether such imbalances arise from interest rate differentials or from exchange rate changes, subject to safeguards to minimize any interpretation that gold is being “remonetized.”

Fourth, that we will participate in a shared guarantee of the Account’s financial position, to be activated upon a decision to terminate the Account, with that decision subject to veto by either the U.S. or a majority of the depositors.

Fifth, that we are not prepared to agree to calls on this guarantee in advance of a decision to terminate the Account.

If an arrangement along these lines can be negotiated, and there is at least a reasonable chance, the Account would entail minimal costs or potential exposure to costs for the U.S. The interest rate paid to the Account would be a market rate, comparable to what the Treasury would have to pay on borrowings from any other source. The ultimate guarantee would be shared, would be payable upon liquidation, would be subject to U.S. veto, and in all likelihood would never be called.

The inter-agency International Monetary Group chaired by Tony Solomon has been closely involved in developing U.S. positions throughout the negotiations, and is unanimously agreed on the course recommended above. In addition, Tony has consulted periodically with Senate Banking Committee members Proxmire, Stevenson and Heinz, Senator Javits, and Chairman Reuss and others on the House Banking Committee. They are very supportive of both the broad principle and the specific U.S. negotiating objectives.⁴

1. Source: Carter Library, National Security Affairs, Staff Material, Special Projects, Hazel Denton, Box 60, International Monetary Fund: 2–11/80. Confidential.
2. No record of the meeting was found.
3. Solomon briefed Miller on the status of the deputy-level negotiations concerning the substitution account in a January 16 memorandum. (National Archives, RG 56, Office of the Under Secretary of the Treasury for Monetary Affairs, Subject Files of Anthony Solomon, 1977–1980, Box 2, G–5)
4. On April 24, Finance Ministers in Hamburg for a meeting of the IMF Interim Committee announced that work on a substitution account would be suspended. (Paul Lewis, “Dollar Plan For I.M.F. Is Shelved,” The New York Times, April 25, 1980, p. D1) In the official IMF history, Boughton offers three explanations for the abandonment of the substitution account. The first two, Solomon’s March 1980 resignation (Boughton notes that Solomon was the initiative’s strongest advocate in the administration) and Volcker’s anti-inflationary monetary policy (which “eased fears of a continuing glut of dollars”), decreased the urgency with which the project was pursued. The third reason (which was “more fundamental,” according to Boughton) “was the dissatisfaction with the stalemate over how to cover exchange risk. Without a consensus on the use of the Fund’s gold as part of an overall burden-sharing plan, the proposal had no hope for success.” (Boughton, Silent Revolution, p. 943)