THE ECONOMIC WEEKLY M a r c h 4 , 1961

The Keynes-Triffin Plan on International Liquidity

C U R R E N T L Y the dollar is under severe internat ional economic

pressure. Countries holding a large stock of dollars as currency reserves are gradual ly convert ing idem into gold. Consequently, the Uni ted States balance of payments reflects a steady flow of gold out of the country. The gold stock has declin­ed to very near the ''safe l i m i t " of $17,000 bi l l ions . Even in the Lou­don Cold Market which supplies prac t ica l ly 80 per cent of the world's total requirements, the price of gold has for some time now. shown a consistent p remium over the officially fixed d o l l a r / g o l d pa r i t y of 8.15.00 per ounce of fine gold.

This development has brought into sharp focus the problems of internat ional monetary pol icy. Be­fore considering the problems one has to lay down the goals that are nought to be realized. They may be considered to be three in number :

(a) the maintenance of wor ld prosperity at higher rates of g r o w t h ;

(b) the re turn to the classical concept of free w o r l d trade and

(c) maintenance of d isc ip l ine in the foreign exchange markets which includes the objective of fu l l con­ve r t i b i l i t y .

Exchange Reserves These objectives are in a sense,

pure abstractions and their attain­ment, by that token of measure­ment can be considered to be pro­blematic. In spite of this, econo­mists strive fo r their realization in the closest possible degree, if not absolutely. Professor Robert Tr i f f in of Yale is one such i n d i v i d u a l . This article reviews his current work "Cold and the Dol lar Crisis" in this connection.

He feels that the above objectives cannot be realised under the exist­ing internat ional monetary arrange­ment. He feels that w o r l d prospers ly cannot grow continuously be­cause it suffers f rom a shortage of internat ional l i q u i d i t y . Just l ike an i nd iv idua l , the nation also requires cash for conducting international transactions. This usually takes the fo rm of exchange reserves. It can be postulated, that when economic prosperi ty increases, the demand for exchange reserves would also get up. If this higher demand is not satisfied, the wor ld would be expos­ed to the dangers of a s lump.

E m p i r i c a l evidence can be mus­tered in support of this hypothesis. The fa i lure of conver t ib i l i ty in the 1920's and the consequent currency disparit ies led to a contraction in w o r l d l i q u i d i t y . This resulted in a crisis of general confidence in the gold standard mechanism and the Great Depression was the consequ­ence. The second near-disaster was averted in 1958. The "German mirac le" and the rap id recovery of the OEEC countries brought about an imbalance between the demand for in ternat ional l i q u i d i t y and its supply. Fortunately, by for tu i tous circumstances, a crisis was averted by a sizeable d i sequ i l ib r ium in the balance of payments of the United States, to the extent of $1.5 b i l l i o n in that year alone. A further deficit of $3.5 b i l l i o n in 1050 and an ex­pected deficit of another $3 b i l l i o n in 1960 have for the time being re­moved the threat of a depression.

This development has. however, raised two new problems. For some t ime past (the orthodox habit of considering gold alone as a pre-

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condit ion of ho ld ing in ternat ional reserves, has been gradually given up in favour of ho ld ing national currencies as internat ional reserves). This serves to supplement gold as

a form of international reserves holding. P r i m a r i l y , only two key currencies are being used for this purpose, namely the dollar and the sterl ing. Even in their case, this is done very haphazardly, so that it poses a perpetual threat to the eco­nomic well-being of that country whose currency is held for this pur­pose. The danger is increased fur­ther since the currency acting as an internat ional reserve loses its inde­pendence in terms of domestic mone­tary pol icy. The action of monetary authori t ies is now subject to the dual loyalty of domestic and inter­national considerations which , in a major i ty of cases, is l ike ly to be confl ic t ing rather than complemen­tary.

The Dangers Apart from the impingement on

the sovereignty of national econo­mic policies, the use of key curren­cies as reserves affects the system of conver t ib i l i ty which is the second modern problem. Exchange rate sta­b i l i t y and discipl ine in the exhange markets has been assiduously rea­lized to a f a i r ly large degree under the auspices of the Internat ional Mo­netary f u n d . However. the stabil i ty of exchange rates depends mainly upon the dollar and the sterl ing, the two key currencies used for accumu­lat ing international reserves. A weak­ness induced in either, be domestic or international pressures, may des­troy the del irate fabric of converti­b i l i t y . This is what actually hap­pened in the 1930's and may hap­pen again in future. A loss of con-

Kersi Doodha

The orthodox habit of maintaining international reserves in gold alone has been gradually given up in favour of holding certain national currencies.

The stability of the exchange rate now mainly depends on the dollar and the sterling, the two key currencies used for accumulating international reserves. A weakness in either, arising from domestic or in­ternational pressures, may consequently destroy the delicate fabric of convertibility.

This happened in the 1930's and may happen again.

A radical solution is to create a new international organisation, an international central hank, to which would he handed over the foreign exchange reserves of all countries.

This is the Keynes-Triffin Plan on International Liquidity. The major obstacle to its implementation would be the' reluctance of countries to give up their sovereignty over reserves. But it can he considered as a proposal to set the ball rolling for future negotiations.

M a r c h 4, 1961 THE ECONOMIC WEEKLY

fidence in the exchange markets would lead the wor ld hack to trade restr ict ions, mul t ip le currency prar-lices bi lateral trade arrangements and economic autarky. Adequate internat ional l i qu id i t y is. thus, vital to the realisation of three objectives of wor ld prosper i ty, tree trade and conver t ib i l i ty . Professor Tri f f in feels that there is a dearth of l iqu id i ty in the wor ld .

The key concepts employed by Professor Tr i f f in for this purpose are two. In the first instance, the rate of growth of industry and trade for the wor ld as a whole is derived f rom t ime series data beginning 1876 (Tab . 1). It shows that on an ave­rage, the annual rate of growth of wor ld industry and trade on a com­pound basis has been of the order of 3 per cent. What has been the corresponding demand for inter­national reserves ? This introduces the second concept of the rat io of gross reserves to imports. Table 2 gives the rat io for certain selected years over the period 1928-57. The average ratio for the wor ld exclud-ing the US dur ing the period comes to 34 per cent.

Demand for Reserves Assuming that the long term rate

of growth of Made and manufactures and the need for reserves remain roughly the same as hi therto, we can predict the fu ture demand for re­serves. If as in the Fund Study, we take the years 1956-66. then the gross reserves required are of the order of $19 b i l l ion . I f . however, we assume that countries wi th very large reserves ( fo r example, U S A. West Germany. Venezuela and Swit­zer land ! wi l l not most probably add to their l i qu id reserves. then the net demand wi l l he $8 b i l l i on . To pre­sume a single unique rate of growth is good for the long term, hut fair ly dangerous in the short per iod. Du r i ng the latter phase, we have, to provide ourselves wi th a spectrum of possib i l i t ies It is more realistic to assume if recent experience is any guide that the growth rate of wor ld trade and manufactures w i l l he over 3 per cent. For example, dur ing the period 1950-57. the average rate of growth has been 6.3 per cent per annum. If. therefore, we assume a 1. 5 or 6 per cent rate of growth, then the required reserves ( in terms of our above qual i f icat ion ) rise to 810.1. $13.7 and $21.1 b i l l i on , res­pectively.

Who is going to supply this l iqu i ­d i t y Norma l l y , gross reserves are

a sum total of gold and fore ign cur­rencies and foreign assets. If the increment in the stock of wor ld gold is assumed to be of the order of 1.5 per cent per annum, then gold alone for the decade ending 1966 w i l l he suppl ied to the tune of $7 bi l l ions, or just enough to guarantee a 3 per­cent rate of growth on our assump­tions. Any higher rate of growth w i l l experience a gap in internat ion­al l iqu id i ty which w i l l he met by an increase in the percentage of fore ign exchange held as internat ional re-serves. f o r example, the percentage of foreign exchange to total reserves would rise sharply f rom 15 per ce r l . to 57. 65 and 71 per cent, if rates of growth in wor ld trade are assumed to be of the order of 3 . 4 . 5 and 6 per cent, respectively.

This trend is extremely disquiet­ing for the realisation of the object­ives of internat ional monetary pol icy. Says Professor Tr i f f in. " I t seems extremely unl ikely that the growth of dol lar or sterl ing balances can provide a lasting solut ion to the in­adequacy of gold product ion to satisfy prospective requirements for internat ional l iqu id i ty in an expand­ing world economy" (p 5 7 ) . For the time being, the issue has been avoided, but time is " r u n n i n g shor t " , and " the danger is increasing dai ly" . Any ' " further inaction and compla­

cency may lead to a repet i t ion in a different f o rm of the 1931 collapse of |he gold exchange s tandard" (p 58)

Keynes-Triffin Plan

In view of this grave threat, the solution offered by Professor Tri f f in is equally radical . He proposes the ' ' internat ional izat ion of the foreign exchange component of wor ld mone­tary reserves" (p 10), This is to be accomplished by creatinig a central

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T H E E C O N O M I C W E E K L Y M a r c h 4, 1961

bank for central banks, a new or­ganisation to be brought into f i r ing by modi fy ing the Internat ional Monetary Fund. Since the proposal has evolved out of the Keynesian recommendations for a Clearing Union , it has come to he popular ly rai led the Keynes-Triffin Plan (K T P l a n ) .

The articles of the K T Plan would provide inter alia, for an unrestrict­ed oppor tun i ty for the f u l l clearing of each country 's bilateral credit and debit, balances. It would also involve handing over of all international reserves as Fund deposits to the modified Fund. The present quota system would thereby be abolished. As the success of this measure w i l l depend upon the cooperation of the pa r t i c ipa t ing countries. Professor Triffin feels that fu l l compliance of the above provis ion may not invoke a favourahle response. He. there­fore, proposes that in i t i a l ly members may he asked to deposit w i th the Fund only a certain por t ion (say 20 per cent l of their gross monetary reserves.

On the basis of a 20 per cent in i t ia l deposit. Professor Triff in as­sumes the Fund resources would he around $11 b i l l i o n wi th a possi­b i l i ty of annual increase by a cons­tant coefficient of 0.20 caused by future rise in members" reserves. However, only half of the above amount could he lent out. since a country cannot be a debtor and a creditor at the same t ime. This . therefore, restricts its. lending capa­city. A possible way out suggested by Professor Tr i f f in is to raise the in i t i a l percentage of deposits or issue medium-term gold certificates payable either in gold or in excess Fund deposits. Al ternat ively . he suggests an impos i t ion of higher deposit requirement upon that p in -l ion of each member's reserves which exceeds the average ratio of world monetary gold to w o r l d im­ports.

Full Convertibility The accumulat ion of credit balan­

ces in the f o r m of deposits w i t h the. Fund carries w i t h it a r ight to fu l l and absolute conver t ib i l i ty into any currency or gold on demand by creditors. Th i s w i l l enable par t ic i ­pating countries to insure them­selves against risks of exchange fluctuations, inconver t ib i l i ty , block­ing, or even default . It w i l l also en­able them to count the Fund depo­­­ts as a normal and variable com­

ponent of their monetary reserves required for gold cover purposes, wherever legal requirements still persist.

The grant of credit facil i ty to member countries is not to follow the automatic p r inc ip le . This is to safeguard the possible inf la t ionary bias in the new scheme. This objec­

tive, can he achieved in two comple­mentary 'safe' ways. The first is to impose a unanimity clause on all important lending decisions, or a qualif ied vole of. say two-thirds, three-fourths, or four-fifths major i ­ty. The second may be to l imi t the lending capacity of the f u n d . This can be achieved on tin- basis of an

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M a r c h 4 , 1961 T H E E C O N O M I C W E E K L Y

e q u i l i b r i u m theorem, creation of credit "sufficient to preserve an ade­quate level of in ternat ional l i q u i d i ­t y ' .

The assets acquired by the modi­fied Fund w i l l generally consist of three elements : gold, net creditor claims already accumulated w i t h the Fund, and l i q u i d or semi- l iquid fo re ign exchange holdings. The f i rs t type of asset, go ld , creates no pro­blem. But in so far as l i q u i d assets

are concerned. Professor Triff in sug­gests that the Fund should be em­powered to sell this paper in an order ly manner. This can be done by l i qu ida t ing them at an annual rah of. say, 5 per cent. Likewise, the sale of currency reserves can also be conducted on the assumption of a stable fore ign exchange market .

Given the above modifications, the p rob lem of l i q u i d i t y is l ike ly to be successfully solved. The major ob­

stacle to the scheme, perhaps, steins from the conservative and cautious at t i tude of w o r l d central bankers.. They wou ld be chary to give up a part of their sovereignty over re­serves. The K T Plan can, neverthe­less be considered as a proposal to start the ball r o l l i ng for future negotiations. The wor ld no doubt needs a central bank if b l i n d econo­mic forces are not to dominate 'he in ternat ional monetary mechanism.