The present Part of this book has thus far considered monetary unions in the strict sense of the definition which was formulated for that purpose. Earlier chapters1 have considered the State, societary and institutional theories of money, and some of the issues associated with them. As a result, this book has thus far placed a focus on what may be described as the two extremes of the monetary spectrum. At one end, one finds a State which issues its own currency and exercises exclusive sovereignty over its own monetary system. At the other end, one finds the eurozone Member States which have irrevocably transferred their monetary sovereignty to the European Union.2 As is well known, the political desire to stand at one extreme or the other has provided much fertile ground for the debate over the merits (or otherwise) of a monetary union in the context of the national sovereignty of the participating Member States. But between these two extremes lie a number of different types of monetary organization or arrangement which may have differing degrees of impact on the national monetary sovereignty of the States concerned.3 In this context, it is proposed to examine the following subjects:
(a) international monetary institutions;
(b) the common organization of monetary systems;
(d) exchange rate pegs;
(e) currency boards;
(f) monetary areas; and
(g) monetary agreements.
In the present context, monetary institutions are international organizations the principal and specific object of which is the initiation and implementation of monetary policies and facilities. In terms of characterization, it is thus necessary to exclude various types of organization from the present discussion. At one end of the spectrum, it is necessary to exclude institutions such as the International Bank for Reconstruction and Development (the World Bank),4 the International Finance Corporation, the European Investment Bank, and the European Bank for Reconstruction and Development; such institutions are involved in the borrowing and lending of money, but their activities lie outside the field of monetary policy. At the other end of the spectrum, it is necessary to exclude institutions whose objectives are of an essentially economic nature and which may therefore have an incidental impact upon issues of monetary policy. A significant illustration of this type of institution is provided by the Organisation for Economic Co-operation and Development (OECD), which was established by a treaty of 14 December 1960.5 Given the relatively limited scope of the current line of enquiry, it is perhaps also necessary to exclude the Bank for International Settlements, which accepts deposits from, and carries out other transactions on behalf of, many central banks and also plays a funding role in certain situations. It also provides a forum for the development of common standards in the field of bank supervision and capital adequacy.6 These roles have great practical importance for the international financial system but they are not directed towards the monetary policy of its Member States.7
In the strictly monetary sphere, paramount status doubtless attaches to the International Monetary Fund (IMF), an international organization currently comprising some 187 member countries.8 The Fund was conceived at Bretton Woods, where its original Articles of Agreement were adopted on 22 July 1944;9 it came into existence on 27 December 1945 and has been in operation since 1 March 1947. It is suggested that the Fund was established to fulfil three broad functions.
First of all, the Fund is required to promote ‘international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems’, ‘to facilitate the expansion and balanced growth of international trade’, ‘to promote exchange stability, to maintain orderly exchange arrangements among members and to avoid competitive exchange depreciation’, and ‘to assist in the establishment of a multilateral system of payments’.10 These broad objectives are naturally followed through in more detail in the ensuing provisions of the Articles of Agreement.11 Secondly, as a method of carrying out these objectives, the Articles of Agreement imposed a system of par values for currencies, allowing for only a limited ‘spread’ in the relevant exchange rate. Both the creation and the collapse of this system have been discussed earlier.12 With effect from 1 April 1978, the Second Amendment to the Articles of Agreement substituted an inherently weaker exchange regime, requiring the Fund to exercise ‘firm surveillance’ over the exchange rate policies of member countries and to ‘adopt specific principles for the guidance of all members with respect to those policies’.13 The provisions for exchange rate surveillance are naturally written in fairly general terms, but these are linked to the more specific obligation on member countries to avoid manipulation of the international monetary system.14 Thirdly, in order to increase their liquid international reserves, member countries are allowed access to the Fund’s pool of currencies. Originally, this was derived from the subscriptions of member countries. Such access was available for certain transactions with the Fund, for example, for the purchase of another member’s currency15 or in exchange for the purchasing member’s own currency;16 in addition, a member is at certain intervals obliged to repurchase certain holdings of its own currency in exchange for convertible currencies.17 These transactions gave rise to many difficulties of interpretation18 and they failed to ensure an adequate measure of international liquidity, because the availability of reserve assets—at that time consisting of US dollars or gold—were insufficient to support the growth in world trade. As a result, the Articles of Agreement were amended in 1969 (the Second Amendment) to provide for a system of Special Drawing Rights (SDRs). This was originally designed to support the Bretton Woods system of parities, but it remains in effect notwithstanding the collapse of that system19
An SDR20 is simply an accounting entry in the books of the IMF in favour of participating members, in respect of which the Fund pays interest in terms of SDRs at a rate determined by it.21 The value of an SDR was originally 0.888671 grammes of fine gold, ie equal to the gold value of the ‘classical’ dollar.22 From the summer of 1974—without any amendment to the Articles of the Fund—the SDR was based on the ‘standard basket measure of valuation’ comprising sixteen major currencies.23 Since the date of the Second Amendment to the Fund’s Articles of Agreement, the value of the SDR has been determined by the Fund itself.24 At first, the determination was again based on upon sixteen currencies, but various changes were subsequently made. In July 1978, the Saudi Arabian riyal and the Iranian rial were substituted for the Danish krone and the South African rand—the latter no doubt for political rather than commercial reasons. From 1981, the SDR was the sum of the value of five currencies, namely, the US dollar, the Deutsche mark, the French franc, the Japanese yen, and the pound sterling. The weightings were adjusted in January 1986, with the US dollar then representing 42 per cent of the basket. Since the creation of the euro and the resultant disappearance of the Deutsche mark and the French franc, the SDR basket has necessarily been reduced to four currencies, weighted as follows:25 US dollar (0.660); euro (0.435); Japanese yen (12.1); pound sterling (0.111). The value of the SDR in terms of currencies is published in the financial press and is thus readily ascertainable.26 The SDR has been used as a unit of account in many international treaties, no doubt because its ‘basket’ nature implies a natural hedge against currency fluctuations and because it displays a (limited) degree of independence from individual national currencies.27 But, given the size of the Fund’s membership, it is perhaps surprising that the SDR is based only upon four currencies. This derives in part from the fact that, in order to preserve the status and credibility of the SDR, the currencies within the basket must be freely usable, that is to say (i) it must be widely used to make payment for international transactions, and (ii) it must be widely traded on the foreign exchange markets.28 In order to broaden the composition of the SDR, it has been suggested that a new set of qualfiying criteria could be established. These would focus on a ‘reserve asset criterion’ and would examine sufficient levels of liquidity, the ability to hedge the currency, and the availability of appropriate high-quality interest rate instruments in the currency concerned. The subject remains current at the time of writing.29
SDRs are not really a liability of the Fund itself.30 Rather, they represent a right to access the freely transferable currencies of Fund members, either through voluntary transactions or through the IMF requiring members with stronger reserve positions to purchase SDRs held by weaker members.31 The latter arrangement effectively acts as a liquidity guarantee for the SDR.
It should be noted that, subject to certain procedural rules and obligations of consultation, the creation and allocation of SDRs is a matter for the Board of Governors of the Fund.32 In practice, the necessary level of agreement has been difficult to obtain, and no new allocation of SDRs was made between 1981 and 2009. During that period, the total SDR allocation stood at 21.4 billion. However, in 2009:
(a) a third allocation of SDR 161.2 billion was made in an effort to combat the gathering financial crisis; and
(b) upon the Fourth Amendment to the Articles of Agreement taking effect on 10 August 2009, a special allocation of 21.5 billion SDRs was made to enable all member countries—including more recent signatories—to participate in the Fund on a more equitable basis.33
As a result, total SDR allocation stands at SDR 204 billion.34 Nevertheless, the SDR represents only a small percentage of the world reserve of assets. When it is decided to allocate SDRs, the amount of the allocation is distributed pro rata to all Member States which are participants in the Fund’s Special Drawing Rights Department, according to their respective Fund quotas.35 A participant Member State which subsequently wishes to use SDRs notifies the Fund; in effect, an SDR entitles the participant to obtain an equivalent amount of foreign currency from other participants which are selected by the Fund itself.36 The SDR has also been used in the context of international bond issues and similar transactions. However, it must be said that the private use of the SDR never mirrored the degree of success attained by the private ECU.37
It will be apparent from this discussion that—although the SDR is the unit of account of the Fund—it is not ‘money’ within the theories of money discussed earlier.38 Apart from other considerations, it does not derive its existence from a delegation of monetary sovereignty and is not intended to serve as a generally accepted means of exchange. Nevertheless, and despite the relatively limited allocations, it is plainly recognized as a standard of value and is treated as a reserve asset—a point emphasized by the fact that SDRs could be comprised within the foreign reserves to be made available to the European Central Bank (ECB) upon its foundation.39
The IMF thus creates a narrowly based and limited form of monetary organization, based upon a ‘basket’ currency which is available for utilization by States in the context of their dealings with the Fund.40
Independent monetary systems may occasionally be organized on a common basis. This happened in the case of the Latin Monetary Union which, it should be emphasized, was not a ‘monetary union’ in the sense in which that term has been defined for the purposes of the present work.41 The union was formed between France, Belgium, Switzerland, Italy, and Greece ‘pour ce qui regarde le titre, le poids, le diametre et le cours de leurs espèces monnayes d’or et d’argent’. The union subsisted with effect from 1865 and formally came to an end in 1921.
Efforts to standardize coinage across a number of States are of very limited value, for no single currency is involved and the arrangements do not involve any economic convergence or harmonization of monetary policies. It will therefore be apparent that arrangements of this kind do not have any material impact upon the monetary sovereignty of the States involved.42
On occasion, a State may elect to adopt the currency of another State as its sole currency.43 An arrangement of this kind44 has for many years existed in Liechtenstein, where the Swiss franc circulates as the sole currency.45 More recently, Ecuador has adopted the dollar as its sole currency. The process of dollarization in that country involved three stages. First of all, during the 1990s, businesses voluntarily substituted deposits and other investments in the local currency (the sucre) with their dollar equivalents. Secondly, the Government announced the formal adoption of a dollarization scheme on 9 January 2000, fixing the value of the sucre at 25,000 to the dollar. The statute endorsing this arrangement (the ‘Economic Transformation Law’) was signed into law on 9 March 2000. Finally, on September 2000, sucre notes and coins ceased to be legal tender.46 El Salvador and East Timor likewise adopted the US dollar as their sole currencies, whilst Kosovo and Montenegro adopted the euro in 1999.47
Zimbabwe progressed to an unusual form of dollarization in 2009. As a result of hyperinflation in earlier years,48 confidence in the Zimbabwe dollar evaporated. In response to this situation, the Government allowed the use of any freely traded currency as legal tender.49 The effective abandonment of the local unit was originally stated to be a temporary measure for at least a year,50 but the currency remains suspended at the time of writing. Interestingly, no substitution rate appears to have been prescribed for continuing obligations expressed in the Zimbabwe dollar. It may be that the massive rate of inflation, coupled with an official suspension of the local unit, are sufficient to bring into effect the doctrine of frustration.51 In practice, parties would no doubt have renegotiated their contracts.
Dollarization differs from a monetary union in various respects.52 In particular, no treaty arrangements are necessary;53 the ‘subsidiary’ country merely needs to introduce domestic legislation adopting the ‘parent’ currency,54 conferring upon it the status of legal tender, establishing a timetable for the currency handover, and prescribing a substitution rate for obligations expressed in the former national currency.55 Secondly, the parent country necessarily remains in charge of its own monetary and exchange rate policies; the subsidiary State necessarily has no (formal) influence in that regard. Where no treaty is involved, the subsidiary State cannot be said to have diminished its monetary sovereignty in terms of international law although in practical terms the exercise of that sovereignty is clearly very restricted so long as the arrangements remain in force, because the State cannot operate an independent monetary or exchange rate policy; it could in theory revoke the arrangements and reintroduce its own currency at any time.56 Nevertheless, for reasons given in the preceding sentence, the freedom of action of the subsidiary State in the field of monetary affairs is necessarily very limited; it will, for example, clearly have no representation within the central bank of the parent State in relation to monetary policy discussions.57
It should be appreciated that the foregoing discussion considers only those cases in which the dollar is adopted as a local currency by virtue of legal measures taken in the adopting State and which confer upon the dollar the status of legal tender within the boundaries of that State. Of course, there may be occasions in which the residents of a particular State lose confidence in the local unit such that the dollar is adopted as a means of exchange by general consent.58 In countries which operate a system of exchange control along the lines of the United Kingdom model, it is fair to point out that such a ‘voluntary’ process of dollarization must be unlawful, because residents holding foreign currencies must generally surrender them to authorized dealers or to the central bank.59
A Government may wish to peg its currency at a particular rate against a given foreign currency, perhaps to facilitate trade with the country that issues the reference currency. The rate may either be fixed or may operate within a target range.60 The Government will buy or sell its own currency on the open market, as necessary, to maintain the national currency at its target rate or within its target range.