Choice of a monetary system 67 Table 1.Several possible international monetary regimes (choose one from each column) Role of exchange rates Degree of market in balance-of-payments convertibility for adjustment Reserve asset capital movements I.Fixed exchange rate A.Gold 1.Full II.Adjustable parities B. SDRs* 2.Dual market III.Gliding parities C.US dollars 3.Controlled and other IV.Managed float national currencies V.Free float *Refers to special drawing rights,first created in 1970 by the International Monetary Fund. regardless of the practices that obtain in the rest of the world.Many small countries may prefer II.C.1.with respect to a"mother country"(e.g.,the Sterling Area)even though large countries are on a different regime.But to function,the mixed international regime must still meet certain consistency requirements:the different components must be compatible with one another. Just specifying a regime in these gross dimensions does not indicate how well it will work.That depends,among other things,on how countries behave within the rules and conventions of a particular regime,not merely on the choice of regime. This fact greatly complicates the choice of a regime,since how countries will behave once it is adopted cannot be forecast with certainty.However,some regimes do have technical weaknesses as compared with others.An adjustable peg regime with uncontrolled capital movements will evoke large movements of funds when- ever a change in exchange rates is in prospect,for example,and a gold standard requires balance-of-payments adjustment to take place through variations in domes- tic employment.To point to these difficulties shifts the discussion from possible regimes to the desirability of alternative regimes. Criteria for choosing a monetary regime Choice between alternative regimes requires a specification of objectives,with relative weights to indicate which ones must govern when a conflict arises between This content downloaded from 211.80.95.69 on Mon,24 Jun 201304:23:40 AM All use subject to JSTOR Terms and Conditions
Choice of a monetary system 67 Table 1. Several possible international monetary regimes (choose one from each column) Role of exchange rates Degree of market in balance-of-payments convertibility for adjustment Reserve asset capital movements I. Fixed exchange rate A. Gold 1. Full II. Adjustable parities B. SDRs* 2. Dual market III. Gliding parities C. US dollars 3. Controlled and other IV. Managed float national currencies V. Free float *Refers to special drawing rights, first created in 1970 by the International Monetary Fund. regardless of the practices that obtain in the rest of the world. Many small countries may prefer II.C.1. with respect to a "mother country" (e.g., the Sterling Area) even though large countries are on a different regime. But to function, the mixed international regime must still meet certain consistency requirements: the different components must be compatible with one another. Just specifying a regime in these gross dimensions does not indicate how well it will work. That depends, among other things, on how countries behave within the rules and conventions of a particular regime, not merely on the choice of regime. This fact greatly complicates the choice of a regime, since how countries will behave once it is adopted cannot be forecast with certainty. However, some regimes do have technical weaknesses as compared with others. An adjustable peg regime with uncontrolled capital movements will evoke large movements of funds whenever a change in exchange rates is in prospect, for example, and a gold standard requires balance-of-payments adjustment to take place through variations in domestic employment. To point to these difficulties shifts the discussion from possible regimes to the desirability of alternative regimes. Criteria for choosing a monetary regime Choice between alternative regimes requires a specification of objectives, with relative weights to indicate which ones must govern when a conflict arises between This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
68 International Organization them.It is the liberal Western tradition to place as the ultimate objective the well-being of individual members of society (rather than the power of the state,the wealth of the ruling autocracy,etc.).Individual well-being has both an economic dimension,taken in its broadest terms,and a security dimension,also taken in its broadest terms.The first involves the economic capacity of an individual to pursue his own aims,and the second involves his liberty to do so without unnecessary interference from the state or from other individuals. At this high level of generalization,there is little dispute between major participating countries over objectives of the international monetary system or over any other set of conventions governing relations among nations or men.Disputes, rather,arise over the best way to obtain these objectives,over means rather than over ends.It is nonetheless useful to state the ultimate objectives from time to time,for it frequently happens that means become proximate ends,and in the pursuit of these proximate or intermediate objectives in ever greater technical detail,actors may lose sight of the ultimate objectives and even compromise them for the sake of achieving some instrumental objective.Restrictive balance-of-pay- ments measures by all major nations during the 1960s illustrate the point all too vividly. By what criteria should we judge an international monetary system,having in mind its ultimate purpose of improving the economic well-being and the security of mankind?Four come to mind:(1)economic efficiency,(2)its scope for accom- modating local diversity in objectives,(3)its contribution to harmony in interna- tional relations beyond monetary relations,and(4)its ability to achieve a desired distribution of the gains,both between countries and within countries,that arise from one regime over another.Economists have tended to focus their attention on the first of these criteria,with some attention to the second and the fourth.They have also devoted considerable attention to the technical workability of the numerous variants of alternative regimes. Economic efficiency concerns the effectiveness with which we use the world's limited natural and human resources to make possible the improvement of eco- nomic well-being.The single most frequently used measure is per capita national product,although economists recognize that the figures they actually use to represent this concept can be misleading if not appropriately interpreted.In the context of international monetary reform,economic efficiency has been considered under three broad categories:(1)macroeconomic management,or the degree to which the international monetary system facilities or impedes the full employment of resources and the attainment of price stability;(2)microeconomic efficiency in the use of resources,especially as it is influenced by exchange rates as prices that guide the allocation of resources;and (3)microeconomic efficiency in the use of money as a lubricant for efficient resource allocation.The last of these categories has received the least systematic attention(partly because it cannot now be handled by conventional economic theory)yet,as I discuss below,represents an important area of reservation about a regime of flexible exchange rates. This content downloaded from 211.80.95.69 on Mon,24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
68 International Organization them. It is the liberal Western tradition to place as the ultimate objective the well-being of individual members of society (rather than the power of the state, the wealth of the ruling autocracy, etc.). Individual well-being has both an economic dimension, taken in its broadest terms, and a security dimension, also taken in its broadest terms. The first involves the economic capacity of an individual to pursue his own aims, and the second involves his liberty to do so without unnecessary interference from the state or from other individuals. At this high level of generalization, there is little dispute between major participating countries over objectives of the international monetary system or over any other set of conventions governing relations among nations or men. Disputes, rather, arise over the best way to obtain these objectives, over means rather than over ends. It is nonetheless useful to state the ultimate objectives from time to time, for it frequently happens that means become proximate ends, and in the pursuit of these proximate or intermediate objectives in ever greater technical detail, actors may lose sight of the ultimate objectives and even compromise them for the sake of achieving some instrumental objective. Restrictive balance-of-payments measures by all major nations during the 1960s illustrate the point all too vividly. By what criteria should we judge an international monetary system, having in mind its ultimate purpose of improving the economic well-being and the security of mankind? Four come to mind: (1) economic efficiency, (2) its scope for accommodating local diversity in objectives, (3) its contribution to harmony in international relations beyond monetary relations, and (4) its ability to achieve a desired distribution of the gains, both between countries and within countries, that arise from one regime over another. Economists have tended to focus their attention on the first of these criteria, with some attention to the second and the fourth. They have also devoted considerable attention to the technical workability of the numerous variants of alternative regimes. Economic efficiency concerns the effectiveness with which we use the world's limited natural and human resources to make possible the improvement of economic well-being. The single most frequently used measure is per capita national product, although economists recognize that the figures they actually use to represent this concept can be misleading if not appropriately interpreted. In the context of international monetary reform, economic efficiency has been considered under three broad categories: (1) macroeconomic management, or the degree to which the international monetary system facilities or impedes the full employment of resources and the attainment of price stability; (2) microeconomic efficiency in the use of resources, especially as it is influenced by exchange rates as prices that guide the allocation of resources; and (3) microeconomic efficiency in the use of money as a lubricant for efficient resource allocation. The last of these categories has received the least systematic attention (partly because it cannot now be handled by conventional economic theory) yet, as I discuss below, represents an important area of reservation about a regime of flexible exchange rates. This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
Choice of a monetary system 69 Controversy over the choice of a monetary regime Simply stating the criteria by which alternative international monetary re- gimes should be judged is not the same as determining which one dominates the others,even if the criteria could be fully quantified.Controversy over the choice of an international monetary regime arises in five separately identifiable categories: (1)understandably different preferences over the different distributional implica- tions,actual or perceived,of alternative regimes,(2)different weights attached to the various criteria when compromises must be made between them,(3)different national economic circumstances,even when preferences regarding the criteria are similar,(4)disagreement over the effectiveness of alternative means to achieve agreed ends,and (5)uncertainty about the trustworthiness of other countries with regard to their behavior within any chosen regime.Each of these sources of controversy deserves extended comment,but it is only possible to touch on them lightly here. Distribution Disagreements arising from different distributional implications are perhaps the most straightforward source of controversy,although even here there is much disagreement about what actually are the distributional implications of alternative regimes.Several kinds of gain arising from alternative monetary regimes can be identified. First,there is the question of seigniorage.Traditionally,seigniorage is the gain that accrues to the mint arising from any difference between the commodity value of the materials going into a coin and the monetary value of the minted coin. Strictly speaking,seigniorage is the difference net of the costs of minting,and under a competitive regime of free access to the mint seigniorage will be zero.In the course of time,governments asserted a monopoly over the power to coin money and restricted coinage,and seigniorage-in effect,monopoly rents-accrued to national governments. By analogy,we can ask what happens to the seigniorage,if any,arising from the use of a particular reserve asset under alternative international monetary regimes.3 The seigniorage under a gold standard regime accrues to the owners of gold mines,in the form of greater intramarginal rents on the production of gold than would be the case in the absence of monetary demand for that metal.Not surprisingly,among nations the Union of South Africa and the Soviet Union have been the two most consistent supporters of returning to gold as the principal international reserve asset;these two countries are the first and second largest Herbert G.Grubel."The Distribution of Seigniorage from International Liquidity Creation," and Harry G.Johnson,"A Note on Seigniorage and the Social Saving from Substituting Credit for Commodity Money,"in R.A.Mundell and A.K.Swoboda,eds.,Monetary Problems of the International Economy (Chicago:University of Chicago Press,1969),pp.269-82,323-29. This content downloaded from 211.80.95.69 on Mon,24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
Choice of a monetary system 69 Controversy over the choice of a monetary regime Simply stating the criteria by which alternative international monetary regimes should be judged is not the same as determining which one dominates the others, even if the criteria could be fully quantified. Controversy over the choice of an international monetary regime arises in five separately identifiable categories: (1) understandably different preferences over the different distributional implications, actual or perceived, of alternative regimes, (2) different weights attached to the various criteria when compromises must be made between them, (3) different national economic circumstances, even when preferences regarding the criteria are similar, (4) disagreement over the effectiveness of alternative means to achieve agreed ends, and (5) uncertainty about the trustworthiness of other countries with regard to their behavior within any chosen regime. Each of these sources of controversy deserves extended comment, but it is only possible to touch on them lightly here. Distribution Disagreements arising from different distributional implications are perhaps the most straightforward source of controversy, although even here there is much disagreement about what actually are the distributional implications of alternative regimes. Several kinds of gain arising from alternative monetary regimes can be identified. First, there is the question of seigniorage. Traditionally, seigniorage is the gain that accrues to the mint arising from any difference between the commodity value of the materials going into a coin and the monetary value of the minted coin. Strictly speaking, seigniorage is the difference net of the costs of minting, and under a competitive regime of free access to the mint seigniorage will be zero. In the course of time, governments asserted a monopoly over the power to coin money and restricted coinage, and seigniorage-in effect, monopoly rents-accrued to national governments. By analogy, we can ask what happens to the seigniorage, if any, arising from the use of a particular reserve asset under alternative international monetary regimes.3 The seigniorage under a gold standard regime accrues to the owners of gold mines, in the form of greater intramarginal rents on the production of gold than would be the case in the absence of monetary demand for that metal. Not surprisingly, among nations the Union of South Africa and the Soviet Union have been the two most consistent supporters of returning to gold as the principal international reserve asset; these two countries are the first and second largest 'Herbert G. Grubel. "The Distribution of Seigniorage from International Liquidity Creation," and Harry G. Johnson, "A Note on Seigniorage and the Social Saving from Substituting Credit for Commodity Money," in R. A. Mundell and A. K. Swoboda, eds., Monetary Problems of the International Economy (Chicago: University of Chicago Press, 1969), pp. 269-82, 323-29. This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
70 International Organization producers of gold in the world,and stand to gain the most in seigniorage from reliance on gold. The seigniorage question has recently been raised in connection with the use of national currencies,mainly the US dollar,as international reserve assets.It has been alleged that the United States gains substantial seigniorage by virtue of international use of the dollar,and that this particular distribution of the gains from a monetary system to the world's richest country is perverse. The debate is too complicated to explore thoroughly here,but the presence of seigniorage in this case is not in fact self-evident.It is undeniably true that international use of the dollar is a convenience to the American traveler,who does not always have to buy foreign money because his dollars are widely acceptable.In that respect,international use of a national currency is like international use of a national language:it confers benefits of convenience on the residents of the home country.But that is not seigniorage.And in any case,utilitarian calculation would suggest that international use of both the dollar and of English as the money and the language of convenience is optimal,since Americans represent by far the largest group of world travelers.(Where,as in southern Europe,Germans or others are the dominant group,their currency is similarly usable.) Foreign holdings of US currency notes represent an inconsequential portion of foreign dollar holdings.Most official dollar holdings,those that constitute international reserves,are held as interest-bearing securities,such as Treasury bills and certificates of deposit.To the extent that the markets in these securities are competitive,and in fact financial markets for large transactors are among the most competitive markets anywhere,no seigniorage exists,i.e.,no special gains arise from a privilege of currency issue.The gains from financial specialization are of course present,but they are diffused widely to all users of the financial system,foreign as well as domestic,partly in the form of interest payments.It simply represents another form of international specialization,such as that associated with com- modity trade,leading to mutual gain.This is true even when it is observed that overall the United States has borrowed short and lent long,earning the difference in yield between short-term and long-term assets.Under competitive conditions,this difference merely represents the costs and risks associated with financial inter- mediation;again no special gain arises,and again it represents just another form of mutually beneficial specialization.4 Finally,it has been suggested that the United States has reaped a special gain by "borrowing"extensively abroad (international use of the dollar,looked at from the other side of the transaction,represents borrowing by the United States from the rest of the world,just as a checking account represents borrowing by the bank 4These arguments require some qualification.If competitive banks are subject to non-interest- bearing reserve requirements,as they are in the United States,then the interest rate on their certificates of deposit will be correspondingly reduced,and some seignorage does arise. Furthermore,from 1963 to 1974,the United States imposed taxes (the Interest Equalization Tax)and other restrictions on capital outflow from the United States,with the encouragement and approval of many European countries,and such restrictions on financial intermediation would again give rise to some seigniorage. This content downloaded from 211.80.95.69 on Mon,24 Jun 201304:23:40 AM All use subject to JSTOR Terms and Conditions
70 International Organization producers of gold in the world, and stand to gain the most in seigniorage from reliance on gold. The seigniorage question has recently been raised in connection with the use of national currencies, mainly the US dollar, as international reserve assets. It has been alleged that the United States gains substantial seigniorage by virtue of international use of the dollar, and that this particular distribution of the gains from a monetary system to the world's richest country is perverse. The debate is too complicated to explore thoroughly here, but the presence of seigniorage in this case is not in fact self-evident. It is undeniably true that international use of the dollar is a convenience to the American traveler, who does not always have to buy foreign money because his dollars are widely acceptable. In that respect, international use of a national currency is like international use of a national language: it confers benefits of convenience on the residents of the home country. But that is not seigniorage. And in any case, utilitarian calculation would suggest that international use of both the dollar and of English as the money and the language of convenience is optimal, since Americans represent by far the largest group of world travelers. (Where, as in southern Europe, Germans or others are the dominant group, their currency is similarly usable.) Foreign holdings of US currency notes represent an inconsequential portion of foreign dollar holdings. Most official dollar holdings, those that constitute international reserves, are held as interest-bearing securities, such as Treasury bills and certificates of deposit. To the extent that the markets in these securities are competitive, and in fact financial markets for large transactors are among the most competitive markets anywhere, no seigniorage exists, i.e., no special gains arise from a privilege of currency issue. The gains from financial specialization are of course present, but they are diffused widely to all users of the financial system, foreign as well as domestic, partly in the form of interest payments. It simply represents another form of international specialization, such as that associated with commodity trade, leading to mutual gain. This is true even when it is observed that overall the United States has borrowed short and lent long, earning the difference in yield between short-term and long-term assets. Under competitive conditions, this difference merely represents the costs and risks associated with financial intermediation; again no special gain arises, and again it represents just another form of mutually beneficial specialization.4 Finally, it has been suggested that the United States has reaped a special gain by "borrowing" extensively abroad (international use of the dollar, looked at from the other side of the transaction, represents borrowing by the United States from the rest of the world, just as a checking account represents borrowing by the bank 4These arguments require some qualification. If competitive banks are subject to non-interestbearing reserve requirements, as they are in the United States, then the interest rate on their certificates of deposit will be correspondingly reduced, and some seignorage does arise. Furthermore, from 1963 to 1974, the United States imposed taxes (the Interest Equalization Tax) and other restrictions on capital outflow from the United States, with the encouragement and approval of many European countries, and such restrictions on financial intermediation would again give rise to some seigniorage. This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions
Choice of a monetary system 71 from the depositor)and then depreciating the real value of its extensive debt by generating inflation.Thus the United States can allegedly impose an inflation tax on the rest of the world.But this assertion presupposes that interest rates do not adjust fully to compensate for the expected rate of inflation.The fact that US Treasury bill rates carried an average yield of 7.02 percent in 1973 compared with only 3.95 percent in 1965,both boom years,is surely explainable largely by an expectation in the latter period of more rapid inflation.If the adjustment in interest rates is complete,the inflation tax can be levied only on non-interest- bearing dollar assets,of which central banks hold relatively little.A gain of course can arise during a period of changing expectations when interest rates have not adjusted fully to the new situation,and during such a period this version of the seigniorage argument has some merit.But otherwise it is not compelling. The seigniorage question arises most explicitly in a regime with an inter- national fiduciary asset such as the IMF's special drawing rights(SDRs),for they represent a form of costless money that carries purchasing power.How they are allocated seems to confer real benefits directly on the recipients,and the complaint has been voiced that allocation according to the present IMF quotas,over 70 percent of which are assigned to the industrial countries,represents an undesirable and even an unfair system of distribution.The issue has been brought forward in current discussions of international monetary reform as a proposal to link SDR creation and development assistance by shifting the allocation of new SDRs heavily toward the less developed countries.Indeed,the latter countries as a group have all but made some movement in this direction a precondition for their approval of any monetary reform.(Again the issues are too complicated to be discussed fully here.5) Many observers fear that such a link would undermine the success of the SDR as a reserve asset,and thereby nullify its principal purpose,which most countries,at least at the level of rhetoric,purport to share,for the sake of a secondary distributional objective.Moreover,even the issue of whether there is true seignio- rage here at least requires some further analysis,since the IMF quota formula for allocating SDRs purports to measure,with admitted imperfection,the liquidity needs of different nations;to the extent that it does so accurately,allocation of SDRs results in no net transfer of resources over time,and thus in no real seigniorage (i.e.,no greater consumption or investment than otherwise). Seigniorage as a source of distributional gain has drawn the greatest attention from economists,although in practice it is perhaps the least important of the distributional effects.Several other distributional effects arising from a reserve currency standard based on some national currency (formerly the pound sterling, more recently the dollar)can be mentioned.First,it has been claimed that the dollar exchange standard gave the United States much wider scope to pursue its preferred domestic economic and other policies,even its foreign policies,than was available to other countries.The United States could simply cover any resultant sFor a convenient summary of the debate,with extensive references to the literature,see Y. S.Park,The Link Between Special Drawing Rights and Development Finance,Essays in International Finance,no.100(Princeton,N.J.:Princeton University,September 1973). This content downloaded from 211.80.95.69 on Mon,24 Jun 201304:23:40 AM All use subject to JSTOR Terms and Conditions
Choice of a monetary system 71 from the depositor) and then depreciating the real value of its extensive debt by generating inflation. Thus the United States can allegedly impose an inflation tax on the rest of the world. But this assertion presupposes that interest rates do not adjust fully to compensate for the expected rate of inflation. The fact that US Treasury bill rates carried an average yield of 7.02 percent in 1973 compared with only 3.95 percent in 1965, both boom years, is surely explainable largely by an expectation in the latter period of more rapid inflation. If the adjustment in interest rates is complete, the inflation tax can be levied only on non-interestbearing dollar assets, of which central banks hold relatively little. A gain of course can arise during a period of changing expectations when interest rates have not adjusted fully to the new situation, and during such a period this version of the seigniorage argument has some merit. But otherwise it is not compelling. The seigniorage question arises most explicitly in a regime with an international fiduciary asset such as the IMF's special drawing rights (SDRs), for they represent a form of costless money that carries purchasing power. How they are allocated seems to confer real benefits directly on the recipients, and the complaint has been voiced that allocation according to the present IMF quotas, over 70 percent of which are assigned to the industrial countries, represents an undesirable and even an unfair system of distribution. The issue has been brought forward in current discussions of international monetary reform as a proposal to link SDR creation and development assistance by shifting the allocation of new SDRs heavily toward the less developed countries. Indeed, the latter countries as a group have all but made some movement in this direction a precondition for their approval of any monetary reform. (Again the issues are too complicated to be discussed fully here.5) Many observers fear that such a link would undermine the success of the SDR as a reserve asset, and thereby nullify its principal purpose, which most countries, at least at the level of rhetoric, purport to share, for the sake of a secondary distributional objective. Moreover, even the issue of whether there is true seigniorage here at least requires some further analysis, since the IMF quota formula for allocating SDRs purports to measure, with admitted imperfection, the liquidity needs of different nations; to the extent that it does so accurately, allocation of SDRs results in no net transfer of resources over time, and thus in no real seigniorage (i.e., no greater consumption or investment than otherwise). Seigniorage as a source of distributional gain has drawn the greatest attention from economists, although in practice it is perhaps the least important of the distributional effects. Several other distributional effects arising from a reserve currency standard based on some national currency (formerly the pound sterling, more recently the dollar) can be mentioned. First, it has been claimed that the dollar exchange standard gave the United States much wider scope to pursue its preferred domestic economic and other policies, even its foreign policies, than was available to other countries. The United States could simply cover any resultant 'For a convenient summary of the debate, with extensive references to the literature, see Y. S. Park, The Link Between Special Drawing Rights and Development Finance, Essays in International Finance, no. 100 (Princeton, N.J.: Princeton University, September 1973). This content downloaded from 211.80.95.69 on Mon, 24 Jun 2013 04:23:40 AM All use subject to JSTOR Terms and Conditions