Money & The IMF

Money

Money is anything which is customarily used as a medium of exchange and measure of value.  Classically, money has the characteristics of being a medium for storing value over time, a unit or measure of value and a means of exchange.  Money can be any stock or valuable commodity which is transferable and capable of being used as a means of exchange.

Money is usually officially backed by the force of law.  Official money or legal tender is generally issued by governmental authorities such as a central bank, treasury department or other government-controlled institution.

Private parties may agree to settle debts in something other than money.  However, only the Euro as the established currency is legal tender within the State, in default of agreement otherwise.

Certain official monies may be used in inter-government transactions.  This includes reserve currencies, including in particular IMF Special Drawing Rights.

Money is measured nominally.  Although the value of money may change, the nominal value does not change in itself. An obligation to pay €100is satisfied by payment of €100 euro if €100 has fallen or risen in value relative to some other measure of value by the date for completion or payment.

Transactions Terms

Under the Convention on Contracts for the International Sale of Goods, the place of payment is usually the place of delivery if such is designated.  Otherwise, it is the seller’s place of business.

A person selling goods internationally faces the risk of inflation and exchange rate fluctuations Some countries’ currency is not exchangeable or constantly loses value against the major world currencies.

Persons subject themselves to exchange-rate risk and inflation risk by agreeing to obligations to pay or accept payment in a nominal amount.  In some countries, a revaluation of debt is allowed where there is a delay in payment.

This is not allowed in Ireland, the United Kingdom or the United States.  However, there is a statutory provision for interest on late payment of commercial debts, which can be varied or excluded by the contract.

Parties to a contract are generally free to select the currency in which it is to be settled.  The place of settlement should also be specified. It may be implied.

Many countries allow a foreign money obligation to be satisfied by payment in the local currency at the exchange rate on the due date.  In the absence of the selection of a place of payment, the rules applicable to the transaction may determine the place of payment.

Price Variation Management

Parties may maintain value and ensure that payment maintains its value by a clause providing for the maintenance of value.  This adjusts the price in accordance with inflation or exchange rate movements.  It is simpler to designate a stable, established currency as the currency of payment.  International currency such as the Euro, Dollar or Yen may be designated.

Another mechanism to hedge against currency fluctuations is to pay a price against a weighted basket of currencies.  Different currencies will have specified weightings. It is common to use an official basket established by international organizations such as the IMF Special Drawing Rights.

SDRs are international reserve assets that member countries of the IMF can use as part of their foreign currency and gold reserves.  They may use it for payments.  The value is set daily by reference to a basket of four major currencies, namely the Euro, the Yen, the Pound Sterling and the Dollar.

International special drawing rights were introduced in 1969. They were introduced because the then stock of reserves was not sufficient to deal with the increase in the level of world trade.  At that time, the reserve assets were gold and the US. dollar.  The special drawing rights are a supplementary asset which the IMF can allocate to members as the need arises.  The IMF publishes daily quotations for special drawing rights.

Gold Standard

The gold standard operated as the basis of the international monetary system during the 19th and earlier part of the 20th century. There was free circulation of gold coins of a standard specification.

If a state exported more than it imported, it would accumulate gold, and its domestic prices would rise.  This would tend to decrease its exports and increase demand for imports.  Eventually, equilibrium was re-established. The system is limited by the supply of gold.

The original gold standard broke down on the eve of the First World War.  In the 1920s, the gold bullion standard was introduced.  States no longer minted gold coins.  The currency was backed by gold bullion, and they agreed to buy and sell at a fixed price.

After the onset of the Great Depression, there was a widespread lack of confidence in currencies, and state treasuries could not meet the demands for gold.  With limited supplies, states were forced to abandon the gold standard, and their currencies became fiat currencies, backed only by the sovereign state.

IMF

The IMF was formed after the Second World War in order to deal with the deficiencies in the monetary system that emerged during the Great Depression.  The IMF identified the lack of convertibility of currencies and the lack of a standard for determining national currencies as factors which had caused and prolonged the depression.  It oversaw monetary and exchange-rate policies and became the guardian of a code of conduct.

The articles of agreement for IMF established a system of currency exchange. This initially related to the value of gold but later became based on exchange agreements. It also provided a system of currency support to allow the IMF to provide short-term financial resources to help states and correct imbalances.

States were obliged to submit to a system of surveillance to ensure they abided by the code of conduct in their monetary relationships.  They could not borrow or lend at unsustainable levels.  They could not engage in protracted one-way interventions in the exchange markets.  They were required to follow the appropriate monetary and fiscal policies for balance of payments purposes.

The surveillance consists of dialogue and advice from the IMF. It appraises each country’s economic position annually.  It advises the parties on policies conducive to stable exchange rates and growth.  The IMF’s multilateral surveillance reports are generally published annually in the World Economic Outlook and the Global Financial Stability Report.

IMF members were obliged to contribute certain monies in SDRs to a quota.  This depends on the relative size of the economy.  Quotas are funds available to the IMF to lend to members having financial difficulties. Quotas also determine voting power within the IMF. Most nations’ quotas are reviewed at least every five years and adjusted as appropriate.

IMF Governance

The Board of Governors of the IMF is its executive.  There is a governor and alternate governors representing each IMF state.  The governors and alternate governors are generally heading of Central Banks or Ministers for Finance of the relevant state.  There is an annual meeting.  Participation may be remote/

Functions of the board have been delegated to an executive board made up of a managing director and 24 directors.  The board of governors elects the executive board.  Key matters such as the admission of new members, quota adjustment and other important matters remain the responsibility of the board of governors.

The executive directors several times a week to oversee policies as set by the board of governors.  Generally, the executive board acts unanimously.  It appoints a managing director.

State Obligations

The code of conduct of the IMF obliges states to keep other states informed of their arrangements for exchange-rate value, restrictions on exchange, pursuance of economic policies that will increase in a constructive and orderly way, and the output of that state and of all IMF states.  The code is voluntary.  Ultimately a member may be declared ineligible to borrow or fail to comply and ultimately may be expelled from the IMF by a majority of 85 per cent.

The more prominent functions of the IMF, include supervision of the system of currency exchange, loans to members to support the currency and economy and services to assist in debt and financial policies.

The original system established in 1945 required members to declare a par value at which their currency would be converted into gold. A dollar was fixed at 1/35th for an ounce of gold.  States were obliged to keep their currency pegged within 1 per cent of this value.  Any change outside this band required consultation with the IMF and other fund members.

The system worked relatively well during the prolonged pot-War period of low inflation.  However, by the late 1960s and early 1970s, inflation and unemployment grew sharply in the United States and the American balance of payments and deficits soared. In 1971 the convertibility of the dollar into gold was ended.  In 1973, a 10 per cent devaluation of the dollar took place.

Floating Exchange Rates

The IMF adopted substantial amendments, effective as of 1978.  The revised arrangements remain in force.  Members define their currency value by standards other than gold.  Generally, members tied their currencies to the currencies of another country, the SDR or to a currency basket.

Some countries allow their exchange rate to float.  States may not manipulate their exchange rate to prevent effective balance of payments adjustments or gain an unfair competitive advantage over other members.

States must collaborate with the Fund to promote exchange rate stability, maintain orderly exchange arrangements and avoid competitive alterations. States must intervene in foreign exchange markets as necessary to prevent and moderate sharp or disruptive fluctuations from day to day or week to week.

Exchange Control

Exchange contracts which involve the currency of a state and are contrary to the exchange control regulations of that state, which are consistent with the agreement, are enforceable.  The provision applies to exchange contracts.  These are contracts that have as an immediate object; the exchange of mediums of payment or currencies.

This does not apply to sales contracts, loans and securities contracts.  The regulations make the contract unenforceable in other states.

States may not impose restrictions on payments or transfers involving current international transactions.  These are transactions for current payments, other than transfers of capital.

Restrictions on transactions involving payments in connection with foreign trade, current business services, short-term banking credit, interest, payment of moderate loan amortisation, and moderate remittances for family living expenses are covered.

Member states may not engage in discriminatory currency arrangements or multiple currency practices.  States must buy their own currency from other states who have acquired it as a result of the current transactions.

Members are obliged to furnish the IMF information and to consult with other members when adopting special or temporary currency restrictions.  They abide to collaborate in promoting international liquidity and to work with other members to make special drawing rights, the principal reserve asset in the international monetary system.

IMF Facilities

The IMF acts as a source of short-term funds for members having difficulty in meeting the balance of payments obligations.  Funds are drawn from subscriptions by members.  The IMF may also borrow from commercial banks.

Regular facilities are available for all states, including tranches which may be withdrawn at any time and do not involve the use of credit.  A credit tranche is available up to 25 per cent of its quota where a member faces relatively minor balance of payments difficulties.  A small number of conditions apply.

An extended fund facility applies to allow member states to overcome balance of payments problems for longer periods. Financing of up to 3 years and up to 40 per cent of a member’s quota as available.

Standby arrangements are designed to help countries address the short-term balance of payments problems.  They are effectively bridging loans.  They are usually granted for a year to 2 years and repayment is within a relatively short time.

A concessional IMF facility applies to low-income states with protracted balance of payments problems.  It applies concessional rates of interest. Some 78 low-income countries are eligible.

Contingent Facilities

Contingent facilities were developed during the Asian crisis of the late 1990s as precautionary facility designed to help states with strong economic policies from the risk of financial contagion.

IMF resources may be deployed only subject to conditionality.  Access to tranches and credit facilities is linked to progress in implementing policies which support balanced and sustainable economic growth.

The conditions encourage states to adopt corrective measures early. The criteria seek to protect the state’s domestic social and political objectives and apply a number of performance criteria.

The arrangement is not enforceable nor are they contractual.  They are conditions for financial assistance.

Institutions

The International Bank for Reconstruction and Development, commonly called the World Bank, was established along with the IMF at Bretton Woods in 1944.  It has two subsidiaries: The International Development Agency and the International Finance Corporation.

The World Bank provides finance for development to government and sub-federal divisions.  The International Development Agency provides financing terms for less developed countries.  The International Finance Corporation provides loans to enterprises. Together, these agencies provide substantial assistance to developing countries.

The global environmental facility is managed by the World Bank.  It provides grants and development funds to developing countries for projects dealing with major global environmental concerns, including climate change, biological diversity, water protection and the protection of the ozone layer.  Countries that are a party to the Climate Change Convention or the Convention on Biological Diversity are eligible to receive funds.

The International Fund for Agricultural Development was formed by a special U.S. conference and provides finance for projects that improve food production systems in developing nations.