98. Memorandum From Secretary of the Treasury Simon to President Ford1
Washington, August 28, 1975.Need for Your Advice on Next Week's Monetary Negotiations
I would like very much to meet with you this week to discuss our negotiating positions for the important negotiations next week in which I will be participating. In particular I need your advice on a matter on which Arthur and I are still unable to agree: the gold question which we reviewed with you on June 32 and on which, despite subsequent efforts, we have not been able to reach agreement.3
Because of the gold issue we're in a difficult tactical position. We, along with the French, have held out for a package agreement on the three principal points. The French position has changed. They now indicate a willingness to "unbundle" the issue of gold and quota increases leaving the exchange rate issue for later. There is some question whether this represents a serious position—they are probably aware of our disagreement with the Fed on gold and thus our inability to negotiate. They also probably realize the difficulty in gaining Congressional approval of quota increases in the absence of agreement on the exchange rate issue.
In any case their initiative appears to the world to be positive and forthcoming. They appear to have dropped the trappings of intransigence and have assumed a position of flexibility. Unless Arthur and I can determine a mutually acceptable position on gold, we cannot negotiate on this issue. If they refuse to deal on the matter of exchange rates, we in turn cannot afford to agree on the highly popular issue of quota increases without losing one of our best cards and incurring the enmity of some of our key Congressional supporters on the exchange rate issue.4
Failure next week as a result of our internal difficulties would increase the political pressures for an Economic Summit with a monetary agenda. A Summit with this agenda, originating seemingly as a result of the failure of the "technicians" of the Interim Committee, could be from an economic and political standpoint a high risk, low reward scenario for the U.S.
The solution, it seems to me, is to agree with Arthur on a gold position that provides us with a negotiating basis, one from which we can deal on gold and offer to deal on quotas if after some U.S. concessions the exchange rate issue can also be settled. If the exchange rate issue cannot be settled, we can still indicate a willingness to settle on gold leaving quotas and exchange rates for later. I am sorry to bother you again on this matter but I urgently need your advice.
BackgroundAs background the three principal issues on the IMF Interim Committee's agenda are, an increase in IMF quotas, the exchange rate issue and the gold issue. Those three issues are the final distillation of the Committee's overall charge to develop steps to update the international financial system and to develop some practical measures of financial assistance for LDCs.
1. IMF quota increase—Agreement on an increase of one-third in IMF quotas is close. The quota increase will result in a substantial expansion in the amount which governments can borrow from the IMF in cases of need and entails an increase in the obligations of governments to lend to the IMF when other governments are deserving of assistance. Our present offer is to recommend to Congress that our share in the quota increase be limited to less than one-third. This would drop our overall quota share from 22.9% to 21.9%, and would permit the OPEC countries' quotas to double from 5% to 10%. Under certain circumstances we are prepared to reduce our overall quotas even further so long as this is accompanied by a change in IMF rules defining the size of the majority required for key actions—from the present 80%–85%—to sustain our veto.
2. Exchange rates—This is perhaps the most implacable issue on which we are negotiating. It is directly related to bread and butter concerns, principally the relative competitiveness of nations' goods in international markets and their respective home markets and to the international role of the dollar and the advantages that the French are convinced go with its present role. The French position is that the floats that in varying degrees characterize the world's principal currencies are aberrations and that phased return to the par values called for under the IMF articles is essential. Presently all major countries are in violation of the basic undertakings in the IMF articles with respect to exchange practices. The French have been insistent that their ultimate objective—all must be part of a fixed exchange rate system—must be spelled out implicitly in any language adopted as a substitute for the obsolete article presently in place. I am considering offering to end the interminable debate surrounding the wording of a new article by simply eliminating the obsolete provisions and not replacing them at this time.
Whether this will provide a satisfactory resolution to this issue is problematical. For tactical reasons, discussed later, and for longer run reasons, agreement will be difficult. The fundamental problem involves the desire of the French to improve their relative competitive position by obtaining from their standpoint, a more attractive exchange rate for the franc—a move that requires a fixed exchange rate system within which to operate. The French sorely miss the advantage that the structurally undervalued franc provided in the period starting in 1958 and ending with the float of major currencies including the dollar.
They intellectualize their position by arguing—sometimes with effect, if not with accuracy, that a system of fixed exchange rates exerts discipline and is therefore not inflationary. Recently they have skillfully tapped the world's craving for stability in a dangerous and swiftly changing environment by making a political argument for the "stability" of a fixed exchange rate system. This argument is spurious. Such a system is fixed in name only and lacks the elasticity to adapt without a series of foreign exchange crises to the changes in fundamental economic relationships that are at the source of the disturbing changes that we have all observed. In effect what tends to be fixed is the dollar, i.e., others have much more say about the value of the dollar under the fixed than under floating rates. The French in particular adjusted their exchange rate frequently in the post-war period against a fixed dollar to maintain a highly competitive trading position.
3. Gold—The Interim Committee has agreed that the official international price for gold should be abolished and that the monetary role of gold should be phased down. It is also agreed that the substantial amount of gold held by the IMF should not be immobilized forever. On this point there is agreement that some IMF gold should be put to use and that some constraints or conditions should be applied to official gold sales and purchases in the near future.
The French have either agreed to or appear ready to agree to the following:
- a. The German proposal that a part of the IMF's $7 billion in gold (at the official price of $42 per ounce; the market price is $161) be restituted to members according to their quotas with part being sold in the private market and the proceeds used to establish a trust fund to help selected LDCs. Disposition of the rest of the IMF's gold would await a later decision which would require an 85% majority.
- b. A global limit on official gold holdings under which no government would buy gold when the effect would be to increase total governmental holdings. The reserves held in the form of gold by some countries could increase without a change in the overall amount held by governments (including the IMF).
- c. In addition the French are willing to agree that no government should trade in gold with the objective of trying to peg the price.
- d. The French agreed to re-enter the snake under amended rules which specifically prohibit the settlement of balances in gold. This involved some domestic political risk for the French government and is at variance with long established French theology on the subject.
Arthur feels that this is not the case. He fears that the known longing on the part of some European central bankers to reimpose a gold based system—a system in which the price of gold would be pegged to a currency or to a collection or basket of currencies—will be translated at some point into action. If this occurred, he feels that we would be at a relative disadvantage because this would involve a less elastic and responsive exchange rate system, a diminution in the role of the dollar, and an increase in the relative importance of powers such as France that have large reserves held largely in the form of gold. He also ascribes an inflationary effect if gold were pegged at the present level, roughly four times the official level, and central banks with large gold holdings were able to "write up their reserves." This in turn would lead to a large increase in stated reserves and Arthur and others believe a dangerous and inflationary rise in world liquidity.
I concede part of the last point that international liquidity as distinct from domestic liquidity has increased with the rise in the market price of gold. If the price of gold were pegged and reserves were written up accordingly, it would in large part be a recognition of the fact that gold currently is well above the official price of $42 per ounce. In substance, the increase in international liquidity which Arthur fears has happened. I'm not entirely convinced that this is bad since there has been a need for additional international liquidity. Our inflation problem has its origins in our inability to curb the growth of domestic liquidity and further lapses in this area will set the stage for more inflation—international liquidity control will play a small role.
I doubt the ability of central banks to peg the price of gold if fundamental forces are in the direction of lower prices. I fail to see why efforts to hold up the price of gold would be any more effective today than our efforts to hold down the price of gold at $35 per ounce was in the 1960s.
If market forces are tending to push up the price of gold, central banks could on a frequent basis reset their pegs at excessively higher levels, but they can de facto restate their reserves at market prices right now, as France has done, ignoring the official price of $42 or any new official price.
I believe there are two fundamental forces at work that have a bearing on gold. In our inflationary time governments will part with gold reluctantly. Until prices are stabilized, gold stocks will come down grudgingly in small increments because governments and central bankers are not immune to the store of value aspect of gold, they too like to "hold a little gold."
By the same token a gold based system, a system in which payment deficits are settled by sales of gold from one central bank to another central bank, is improbable because central banks will not wish to part with their gold preferring to settle in some other form—such as dollars or a basket of currencies.
If prices stabilize, the price of gold is likely to fall sharply—an event which I think governments and central banks would be unable to stop. This does not preclude a situation in which certain governments and central banks would not seek under the global limit and in the context of IMF sales to increase their holdings of gold. Such countries would have to accept the risk that gold purchased could depreciate sharply if gold in response to general price stabilization dropped in price. Moreover, the idea that an extraordinary hoard of gold will automatically result in an extraordinary amount of international power regardless of the relative size and efficiency of the hoarding country's economy seems far fetched.
Moreover, we are still holding the world's largest gold stock and this can be a decisive factor in the market for a long time if we wish it to be.5