"138. Most members believe that the provision of capital to developing countries is a problem quite distinct from the creation of reserves and should be achieved by other techniques. They saw disadvantage in an attempt to combine objectives of long-term development finance with the needs of flexibility required for monetary management. From the point of view of international monetary management, full flexibility of decision is called for as to whether assets should be created or not. From the point of view of development, on the other hand, planning both by donors and by recipients requires firm commitments over considerable periods. This would introduce an inflexibility into the monetary aspects of the scheme and thus impair the monetary quality of the asset. The difficulties might not be insuperable if, as was suggested in paragraph 137 above, the amount of reserve creation associated with development finance were kept at a modest fraction of the total creation of reserves. But it would be difficult to resist demands from developing countries, and internal pressures in the industrialized countries, to give aid in this form, which appears to avoid a cost in real resources. There would be a risk that, over time, more of the assets might be created than surplus countries would be willing to acquire. Most members also hold the view that the character of an asset depends to some extent on its quality in case of liquidation of the scheme or of withdrawal of members. In case of liquidation of the scheme, participants would receive long-term IBRD bonds, which might not meet the requirements of liquidity demanded by a central bank. For these reasons, therefore, the idea of combining asset creation with development finance was not widely favored."

It is of course true that the size and timing of the needs for reserve creation are quite different from-and much smaller than-those for development financing. Reserve creation should be decided entirely upon its own merits, and should probably range initially around 4% a year on the average (i.e., about $3 billion, while development financing could probably absorb three to four times as much. Yet, this does not mean that development financing should be ruled out as one of the several purposes to which the lending potential inevitably derived from fiduciary reserve creation should be assigned.

The fear has been expressed that developing countries might, if such a system were adopted, exercise pressure for reserve creation in excess of monetary requirements, thus imparting an inflationary bias to the system. Such a danger, however, is already more than adequately guarded against through the present voting rules requiring an 85% majority of the total voting power for the allocation of Special Drawing Rights. Indeed the real danger is one of excessive conservatism rather than liberality in the activation of SDR's. Moreover, the combined GNP of the more developed countries is now running, for the OECD group alone, at an annual rate of about $1.7 trillion, and increasing at a rate of about $120 billion a year. The inflationary impact of the most ambitious allocation of SDR's ever contemplated so far would be practically negligible in comparison with these figures.

Secondly, apprehensions have also been expressed about the contrasting needs for firm, long-term, commitments in development planning and finance, on the one hand, and for flexibility in the creation of new reserve assets, on the other. Opposite conclusions are drawn from this observation by the Ossola Study Group (p. 70) and by the UNCTAD experts (p. 31). While the Ossola Group fears that monetary flexibility would be sacrified to developmental needs, the UNCTAD experts expect that the latter will have to take into account the unpredictability of reserve creation. All agree, however, that the obstacle is not insurmountable since "even today, neither the IBRD nor IDA has any long-term assurance of additional funds" (UNCTAD Report, p. 31) and since "the amount of reserve creation associated with development finance [could be] kept at a modest fraction of the total creation of reserves" (Ossola Report, p. 70.)

Thirdly, the more conservative members of the Ossola Group argued that the new reserve asset should be distributed only among countries which could be trusted not to remain persistently in deficit and would be able, therefore, to honor their obligation for repayment in operation or, ultimately, in liquidation. This view was opposed by other members and the arguments pro and.com are partticularly worth re-reading today in the light of the provisions later adopted in the drafting of the present SDR Agreement:

"120. In favor of keeping the ownership and circulation of the asset within a limited group of industrialized countries, it was argued that an international

Several central banks, however, including the Bundesbank, have taken a different view on this matter, and acquired long-term IBRD bonds.

asset must be based on credit and that the credit of those who back it must therefore be unquestioned. There must be no room for doubt whether the asset will, in practice, be honored in operation or, ultimately, in liquidation. Deliberatelycreated new reserve assets must, of their nature, initially be distributed without the recipients' having had to forego real resources in order to earn them, but will thereafter command real resources. Care is therefore needed in establishing the group in which they are to be used. A reserve asset is characterized by the expectation that, if it flows out, it should ordinarily be rconstituted in due time. Assets which are specifically created to fulfill the reserve function should, consequently, be distributed only to countries whose balance of payments is likely to move between deficit and surplus and which are, therefore, able to assume the obligations as well as the rights entitled in the convention and its working. More generally, a system which meets the reserve needs of the larger nations will, in practice, benefit all countries.*

"121. The other view here, while recognizing the logic of some of the points made, considers that the limited arrangement would be exposed to disadvantages which would outweigh the advantages claimed for it. For a group of industriallyadvanced countries to increase, by a stroke of the pen, as it were, their own monetary reserves and appear to make themselves thereby the richer, would invite criticism from other countries, who would declare that their own need for more elbow room in their international payments was, proportionately, no less than that of the members of the group. A number of the smaller countries could show that they have maintained a good reserve position and that their balance of payments' record compares favorably with that of countries within the group. It would be arbitrary to deny participation to such countries. In any limited membership, the difficulty of borderline cases is likely to arise. For this reason, those who hold this view favor an approach that is not strictly limited in the width of membership. They prefer an approach that embodies a self-qualifying element and would therefore be more open than a grouping that is strictly limited to a small number of countries. They point out that many countries throughout the world feel, or will feel, a need for growing reserves; yet countries excluded from the group would be able to increase their reserves only by surrendering real resources or attracting capital inflow. To exclude these countries would risk creating a sense of discrimination which would hamper monetary cooperation and understanding and which might well lead to demand for compensation in other ways. As a technical matter, the more limited the group the more likely it is that individual members of the group will accumulate an undue amount of the new asset; this would occur if such members, even when in payments' balance with the entire world, had a surplus with the group and a deficit with the rest of the world."

The basic objection raised in paragraph 120 above of the Ossola report has often been expressed-more naively, but plausibly-in terms of the liquidity criterion of sound banking practice. Short-term indebtedness-such as liquid reserve deposits with the IMF-must be backed by short-term claims. Reserve deposits with the IMF might become "frozen" if they were used for the financing of long-term investments. I commented as follows on this point in my initial proposal for "link." some ten years ago:

"A primary consideration in determining the pattern of Fund investments would be the need to preserve the full liquidity of its members' deposits. It should be noted, however, that the Fund would be in a particularly strong position in this respect as the total amount of its required deposits... could hardly decline in practice, but would on the contrary grow year by year with the increase of world reserves. Any withdrawals of deposits by members whose reserves are de clining would be more than matched by increases in the required deposits of members whose reserves are increasing." 5

Professor Machlup made the same point, in a more striking and wittier fashion, by observing that the amounts, quality, composition and liquidity of a bank's assets are irrelevant for payments among customers of the same bank, and become relevant only for payments to customers of other banks. A commercial bank must retain sufficient liquidity to finance interback payments, a national reserve bank only to finance international payments, and an international reserve

This last argument calls back to mind the remark of one of our former Secretaries of Defense: "What is good for General Motors is good for the country." Gold and the Dollar Crisis, p. 118.

bank only to finance interplanetary payments to persons, banks or reserve banks on the other planets.

In any case, the framers of the SDR agreement can no longer be suspected of entertaining any taboo against long term investments of liquid deposits. Under Article XXV Section 6 and Schedule G of the proposed agreement, 70 percent of the SDR's used by a participating country need not be “reconstituted”—i.e. repaid at any fixed time-and may be tantamount to a straight gift-or at least "consol"-as long as the country continues in deficit and remains a member of the system. The "freezing" of IMF claims under this provision would be greater, if anything, than under the "link" proposal.

Let us observe, finally, that, far from constituting a revolutionary innovation in international monetary practice, the "link" would merely preserve an essential feature of the gold-exchange standard. The accumulation of sterling balances as reserves by foreign central banks traditionally helped Britain finance a larger amount of capital exports particularly to less developed countries-than it could have sustained otherwise. The same was true of the dollar balances accumulated, in the same way, by foreign central banks, and particularly by the surplus countries of continental Europe since the end of World War II. We would have been unable to finance as large an amount of foreign aid and capital exports if surplus countries had cashed their dollar reserves for gold. In essence, the willingness of foreign monetary authorities to accumulate large reserves in the form of sterling and dollar balances enhance the ability of London and New York to provide long-term financing for economic development, private and official, to the countries of the Third World.

The basic assumption underlying the creation of SDR's is that they will have to substitute gradually, but increasingly, in the future for reserve currencies, as well as gold, as a source of increase for world reserves. The constructive role previously played by reserve currencies in development financing should certainly not suffer as a consequence of this shift. What would be revolutionary, but in a retrogressive direction, would be to terminate a "link" which has always existed in the past between the creation of fiduciary reserves and development financing.

THE PRESENT PROPOSAL

The present SDR Agreement will, in principle, distribute SDR's among all participants pro rata of their Fund quotas.

Such a system of allocation is, to my mind, morally repugnant, economically wasteful and politically unviable.

It is morally repugnant to assign the lion's share of SDR's-about 72 percent— to the 25 richest and most capitalized countries in the world—including 36 percent to the United States and the United Kingdom alone-leaving only the remaining 28 percent to be parcelled out among 86 least developed and neediest members of the Fund.

It is also economically wasteful, since any automatic distribution of this sort would contravene the cardinal principle, so often affirmed in previous Group of Ten discussions and reports, that "the process of adjustment and the need for international liquidity are closely interrelated." The improvement of the present adjustment mechanism should indeed be an essential objective of the proposed reforms, and the distribution of the credits that are the unavoidable counterpart of any accumulation of fiduciary reserves should be determined in that light rather by any autematic, and arbitrary, formula. Would you ever think of setting up a new bank which would be committed by its very charter to allot its credits automatically among all prospective customers in strict proportion to their height, or to their waistline, so as not have to bother the Management about deciding on the comparative usefulness of alternative uses of the bank's lending capacity?

Since, however, moral and economic considerations do not always determine governments' policies, a third consideration may be deemed more realistic and relevant. The proposed automatic allocation of SDR's will soon reveal itself as politically unviable in fact. Prospective lenders will oppose desirable SDR activation decisions whenever they feel that such activation would automatically

6 Fritz Machlup. "The Cloakroom Rule of International Reserves: Reserve Creation and Resources Transfer," The Quarterly Journal of Economics, August 1965, p. 343. 7 Ministerial Statement of the Group of Ten and Anner Prepared by Deputies, August 1964. p. 4. For further discussion and references, see also my book on Our International Monetary System: Yesterday, Today and Tomorrow (Random House, 1968), pp. 139 ff.

commit them to underwriting in advance national policies of prospective borrowers in which they have no voice and with which they may fundamentally disagree. This problem is all the more acute as the plan envisages that the initial activation decision will be made for five years at a time. A presumptive guideline of a 4 percent annual increase in current reserve levels would entail a tentative commitment of more than $15 billion, of which more than $5.5 billion would be earmarked for the United States and the United Kingdom alone. Would the prospective surplus countries be willing to sign a blank check of $5.5 billion available to finance U.S. and U.K. policies if they felt, at the time, that this would entail a transfer by them of $5.5 billion of real resources of which 70%, or close to $4 billion might be closer to a gift than to a loan-likely to be used for a resumption of war escalation in Vietnam, or other military or social expenditures which their Governments or Parliaments might regard as highly questionable, or worse?

The present allocation proposal calls to mind a system which this country found totally repugnant on the eve of its birth. “Taxation without representation!" INTERNATIONALLY AGREED SDR'S SHOULD SERVE INTERNATIONALLY AGREED PURPOSES

Such a system will be no more viable tomorrow than it proved to be two centuries ago. If SDR's are to be created by collective agreement, the uses to which they should be put must be also collectively agreed. And it should not be difficult to define such collectively agreed uses which are now begging for resources and to which SDR's could make a significant-even though only partial-contribution. One of these would be the recycling of speculative funds such as contemplated in the "General Arrangements to Borrow" of the IMF. Another would be to supplement, if necessary, the funds available to the IMF to finance its traditional monetary stabilization assistance to members. A third would be to provide some of the resources that might be needed to implement international efforts to stabilize the prices of primary products, as envisaged in the second resolution unanimously adopted at Rio, together with the SDR Outline. A fourth would be to invest in the obligations of IBRD, IDA and other international or regional development institutions, or to enhance the capacity of major financial markets to finance overseas development. A fifth purpose, now that the principle of “nonreconstitution" has been accepted and embodied in the present Draft Agreement, could even be the support of United Nations peace-keeping and other agreed objectives.

A PRACTICAL FIRST STEP

The preservation of the "link" which the present SDR amendment would destroy will require, at an early stage, a renegotiation that will-if precedents are a guide-require many months, or years, to complete.

The U.S. Congress could initiate such a renegotiation by reviving, and broadening, the third recommendation unanimously approved by this Subcommittee on December 6, 1967. The United States Executive Director in the IMF should call for studies and negotiations aiming at rechanelling toward the financing of internationally agreed objectives, such as those mentioned above, some or all of the SDR lending potential now automatically and blindly earmarked for the support of all and every national policies, no matter how economically maladjusting and politically distasteful to other IMF members.

In the meantime, and pending the outcome of such a re-negotiation, all countries, or at least the richest and most developed countries, should be urged to express their intention-or better their commitment-to make supplementary contributions, in their own or in other currencies, to the IDA or other similar institutions, equal to any amounts of SDR's allotted to them under the present Draft Agreement.

The United States should take the lead in issuing such a declaration, either unilaterally, or together with a number of other countries such as those now associated in the Group of Ten.

COMPLEMENTARY REFORMS

This is not the place to rehash other recommendations already endorsed by your Subcommittee. They should, however, be kept in mind and could usefully be reviewed and grouped together in a comprehensive and evolutionary program of international monetary reform. Let me merely list those which appear most crucial to me, with a few comments where necessary:

8 Guidelines for Improving the International Monetary System-Round Two, pp. 7-10.

1. The present pre-requisite for activation is thoroughly absurd and should be replaced by a "Conversion Account" Agreement, merging recommendations 2 and 3 of the September 19, 1968 Report of this Subcommittee (pp. 4-6).

2. Recommendation 4 of the same Report (pp. 6-7) should be amended along the lines suggested on pp. 488-491 of my article in the April 1969 issue of Foreign Affairs: "The Thrust of History in International Monetary Reform." (Particularly the "fork" proposal briefly summarized in the third paragraph of p. 490.) 3. Recommendation 4 of your December 1967 Report (p. 10) regarding the "marshaling of SDR's on a regional basis." 10

4. Recommendation 1(c) of the same Report (p. 5), supplemented to the comments on pp. 2 and 3 of your September 19, 1968 Report, regarding the financing and correction of U.S. balance-of-payments deficits.

5. With proper revisions and up-dating, some of the other recommendations and comments of previous Reports of your Subcommittee which have not yet been acted upon and remain as relevant-or more today as when they were initially issued.

CONCLUSION

I hope to have covered some of the main issues scheduled for today's hearings. As far as the second half of your second question is concerned, I have made it clear that I would make "the link. an integral part of the mechanism through which SDR's are distributed." The voluntary scheme suggested by Mr. Karlik might possibly help balance the conservative bias which the present voting rules might impart to the decisions concerning the amount of SDR's to be activated. I am not fully confident that it would do so, as prospective lenders intent on minimizing their own transfer of resources would regard his proposal as likely to accelerate the actual use made of their contingent lending commitment. Moreover, the proposal remains far short of what I would, for the reasons developed above, regard as necessary to strengthen the adjustment process and preserve the traditional link between the creation of fiduciary reserves and development financing. Yet, I would not presume to prejudge the quirks of a difficult negotiating process, and would not be ready to discard lightly what might indeed prove a negotiable "second-best."

With regard to your third and fifth questions, it is clear that any proposal to determine the overall creation of SDR's in the light of developmental needs rather than monetary criteria would be a kiss-of-death for the negotiation suggested above. This is not to say, however, that the developing countries would not benefit from such a negotiation. The same amount of global SDR creation would transfer a larger amount of real resources to them in the form of development assistance rather than in the form of bullets, bombs, napalm and other military contributions to their freedom and security (!)

Finally, I feel that any answer to your fourth question would impose an arbitrary straitjacket on alternative uses of the SDR lending potential. I would apportion all of the newly created reserves among internationally agreed purposes and in internationally agreed proportions, reflecting the order of priorities entertained at any given time by the members of the Fund. No lone academic should presume to predict the outcome of this continuing negotiating and managing process, even though we shall all continue to participate in the debate and to express individual views which may, or may not, influence the decisons of the officials in charge.

Ten years of intense involvement in the marathon debate on international monetary reform have taught me to be despairingly modest about the short-term impact of unwelcome academic advice on the minds and actions of the officials in charge, but also to be cheerfully sanguine about its longer-run impact upon the same officials-or their successors.

(The following article was submitted by Professor Triffin to supplement his prepared statement:)

See also my previous comments on pp. 142-147 of your September 9, 1968, Hearing, and in Appendix to this paper-a revision and updating of pp. 146-147, facilitating a quick comparison of the relative impact of a worldwide Conversion Account and of a Conversion Account limited to the eight countries of the defunct Gold Pool.

10 See also my testimony in your Hearings of November 22, 1967, pp. 128-157, particularly the penultimate paragraph of p. 132, and the Section headed "III. Pooling" on pp. 138-139.