List of figures
2. The role of law in monetary affairs
2.1 The principle of monetary sovereignty
2.2 The need for cooperation in international monetary relations
2.3 Limiting monetary sovereignty: the Articles of Agreement
2.3.1 Unprecedented legality: 1945 to 1971
2.3.2 Reforming the Articles: 1971 to 1978
2.3.3 Back to sovereignty: 1978 onwards
2.4 The IMF in today’s international monetary system
3. Bilateral surveillance of exchange rate policies
3.1 The original bilateral surveillance regime
3.1.1 The amended Article IV
3.1.2 The 1977 Decision
3.2 The reformed bilateral surveillance regime: the 2007 Decision
3.3 Formal sanctioning powers
4. The legalization of bilateral surveillance
4.1 The concept of legalization
4.1.1 Why legalization?
4.1.2 Measuring legalization
4.2 The legalization of monetary affairs
4.3 The legalization of the original bilateral surveillance regime
4.4 The legalization of the reformed bilateral surveillance regime
4.5 Interim conclusion: low legalization level despite 2007 Decision
5. Exchange rate surveillance in practice: the case of China
5.1 The controversy over China’s exchange rate policies
5.1.1 The evolution of the renminbi regime since 1978
5.1.2 Instruments and intentions for managing the renminbi rate
5.1.3 Critics and advocates of the Chinese exchange rate policies
5.2 IMF surveillance of the Chinese exchange rate policies
5.2.1 Is China in breach of the Articles?
5.2.2 Art. IV consultations with China prior to the 2007 Decision
5.2.3 Art. IV consultations with China after the 2007 Decision
5.3 Interim conclusion: China and the challenges of firm surveillance
6. The choice for soft legalization in exchange rate surveillance
6.1 Uncertainty costs
6.1.1 Measurement difficulties
6.1.3 Goal incongruence
6.2 Sovereignty costs
6.2.1 Reputational damage
6.2.2 Distributional impact
6.2.3 Loss of monetary power
6.3 Interim conclusion: the softness of the law on exchange rates
7. The future of exchange rate surveillance
7.1 Learning from the Fund: a constructivist perspective
7.1.3 The potential of Article IV consultations
7.2 Lessons learned? The IMF as a standard-setter
7.2.1 Standards in the international financial architecture
7.2.2 The track record on IMF standards
7.3 The characteristics of effective surveillance
8. Concluding remarks
9.1 Additional figures
9.2 Glossary of key concepts
9.3 Reprints of the legal provisions on bilateral surveillance
9.3.1 The amended Article IV
9.3.2 The 1977 Decision
9.3.3 The 2007 Decision
Sources of figures
List of figures
Figure 1 Timeline
Figure 2 Powers of the Fund
Figure 3 Surveillance Instruments
Figure 4 The Process of Legalization
Figure 5 Attributes of Legalization
Figure 6 The Legalization of Exchange Rate Commitments
Figure 7 Asian Exchange Rates Against the USD
Figure 8 China’s Foreign Exchange Reserves
Figure 9 China’s Trade in Goods
Figure 10 China’s GDP Growth
Figure 11 US-China Economic Relationship
Appendix 1 IMF Governance
Appendix 2 The Bilateral Surveillance Regime
Appendix 3 The Art. IV Process
Appendix 4 Forms of International Legalization
Appendix 5 China Annual Trend Charts
Appendix 6 China Comparative Indicators
Appendix 7 China Consumer Price Inflation
Appendix 8 The International Financial Architecture
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In the last decade, allegations of currency manipulation have overshadowed the relationship between China and the United States (US). Washington argues that by artificially holding down the value of its currency, the renminbi, the Chinese manage to outpace their rivals in the race for the manufacturing title. Owing to large reserve accumulations – a by-product of its heavy exchange rate management – Beijing is alleged to bring about global imbalances and financial instability. In response, China blames the US for injecting excessive liquidity into the international monetary system – and for threatening the value of its vast dollar holdings.
Beyond the rhetorical mud-slinging, the dispute over the renminbi draws attention to an interesting phenomenon in world politics: the regulatory gap between money and trade. In the international monetary system, states threaten unilateral actions without addressing a supranational framework (Subacchi 2010: 1) – in contrast to the neighbouring area of trade where coordination is thriving. Just recently, China was embroiled in two disputes over trade practices. It accused the European Union (EU) of applying illegitimate tariffs on the import of metal fasteners (Wall Street Journal, 18 July 2011a); and it was incriminated for restricting exports of rare earths (China Daily, 22 July 2011). In both cases, legal settlement was reached with the help of the World Trade Organization (WTO). Considering that even Antigua managed to secure a legal victory against the US over its ban on online gambling (Reuters, 31 January 2008), the exchange of goods and services seems to be governed by firm legal rules – with a powerful institution to boot.
However, this distinction is not entirely accurate, as there is indeed an international body responsible for surveilling exchange rates: the International Monetary Fund (IMF or Fund). According to Art. IV of its Articles of Agreement, the Fund is tasked with overseeing both the international monetary system and the policies of all its members. Yet in practice, the regulatory reach of the IMF is disputed: “Poor countries fear the Fund and choose to suppress its conclusions; middling countries quarrel with it; rich countries ignore it” (The Economist, 29 July 2010). The former Managing Director Dominique Strauss-Kahn conceded that if a country’s policies were a threat to international stability, the Fund could “at best come up with a list of homework tasks, but not make them do the homework” (BBC World Debate, 8 October 2010). No country has ever been found in breach of its monetary obligations since Art. IV was ratified in 1978. As a result, “the focus of legislation concerning the international economy passed to the GATT and the WTO while most countries joined the IMF, which became essentially a foreign aid agency” (Lowenfeld 2010: 583). Shortly before the financial crisis in the late 2000s, Martin Wolf, a leading financial commentator argued that “if the International Monetary Fund did not exist, we would not re-invent it” (Financial Times, 21 February 2006).
Looking back, the Fund has not always appeared so powerless. A US representative warned in 1945 that joining the IMF would amount to “handing over to an international body the power to determine the destination, time, and use of our money [...] and abandoning, without receiving anything in return, a vital part of American bargaining power” (quoted by Gadbaw 2010: 557). In fact, the international community agreed to surrender considerable control over its exchange rates to the IMF between 1945 and 1971. But ever since the collapse of the Bretton Woods system and the Second Amendment, sovereign control over exchange rate policies returned to be “one of the most closely guarded national prerogatives” (Simmons 2000a: 573). Attempts by the Fund to increase its clout over monetary affairs, such as the publication of a new decision on bilateral surveillance in 2007, proved futile in establishing further obligations. To this day, exchange rates are characterised by low levels of legal commitment.
In recent years, currency manipulation has become an increasingly popular subject of research. There is, however, a distinct lack of explanations for the scarce efficacy of Fund supervision. In most cases, the reasoning is circular: there is no enforcement of Art. IV because the IMF has no power to enforce it. Accepting that “the vagueness [of Art. IV] is likely not the result of drafting error” (Mercurio/Leung 2009: 1299), the arguments put forth appear unsatisfactory. They range from historicisms like the observation that “in the 1970s, enforceable, ‘hard’ rules were not common” (Herrmann 2010: 51) to the simplistic claim that “every country wants to retain absolute freedom on the choice of its exchange rate regime” (Pattainak 2007: 300). Other critics blame the IMF’s staff for showing “little inclination to get involved” (Chwieroth 2009: 53) and remaining “asleep at the wheel of its most fundamental responsibility” (Adams 2006: 135), culminating in ad-hominem arguments against the “failure” of the Fund’s management and Managing Director (Mussa 2007: 123).
In addition to their poor explanatory value, these arguments fall short of addressing the systemic reasons for the softness of bilateral surveillance. Since it appears that “high political costs” (Zimmermann 2010a: 55) have limited the degree to which states seek cooperation in monetary affairs, the central question is not why the Fund does not enforce its rules, but rather why it lacks the necessary punch. By incorporating international relations (IR) theory, this paper seeks to explore the motives behind the reluctance to relinquish authority over currency policies to a multilateral body.
Against the backdrop of the renminbi issue – “the elephant in the room” with respect to improper monetary conduct (Eichengreen 2007: 164) –, this paper retraces the unique trajectory of the international law (IL) on exchange rates – from the lawlessness of the gold standard to a highly regulated system under Bretton Woods and back to the obscure arrangement that has prevailed ever since the Second Amendment. Ultimately, it wants to answer the following question raised by Morris Goldstein:
Through the rulings of adjudication panels in the World Trade Organisation and in contrast to what has happened on exchange rate issues, a body of international case law is unfolding – making it clearer what is and what is not internationally-acceptable trade policy on everything from bananas to steel to domestic tax systems. Why isn’t a similar exercise going on for exchange rate policy (Goldstein 2005: 8)?
To analyse the characteristics of bilateral exchange rate surveillance, this paper employs the concept of legalization – a rational institutionalist approach for studying the “move to law” in world politics (Goldstein et al. 2000: 385). In short, it argues that international monetary stability is a public good which, as a collective action problem, provides strong incentives for cooperation. However, the analysis of the bilateral surveillance regime reveals that after the Second Amendment hard legalization no longer served the interests of the IMF membership, while the costs of hard legal rules tipped the scale in favour of soft commitments. Specifically, the paper finds that exchange rates are subject to high uncertainty costs stemming from measurement difficulties, complexity, goal incongruence and subjectivity; as well as sovereignty costs due to reputational damage, distributional impact and loss of monetary power.
The argument is established over the next six sections:
- In the second section, this paper frames the debate on illegitimate currency practices in the historical perspective. It describes the conflicted relationship between monetary sovereignty and international cooperation – and how the IMF’s ability to safeguard monetary stability has continuously eroded since the Second Amendment.
- The third section provides a stocktaking of the legal framework for exchange rate surveillance – illustrating the legal provisions established in 1978 to govern the members of the IMF in their currency policies and the reform of bilateral surveillance in 2007.
- The fourth section applies the concept of legalization to analyze the 2007 reform. Rooted in rational institutionalism, legalization argues that self-interested states will choose harder legal rules to solve collective action problems. By comparing the two bilateral surveillance regimes in terms of obligation, delegation and precision, this section finds that hardening the law on exchange rates has proved difficult. In particular, increasing the precision level appears an impediment to exchange rate surveillance.
- The fifth section substantiates the findings of the previous section by showing surveillance in practice with the “hard case” of China. Retracing the IMF’s Art. IV consultations with Beijing before and after the 2007 reform, it illustrates the challenges involved in monitoring the exchange rate of a large economy.
- The sixth section explains the choice for the soft legalization of exchange rates. Facing a number of sovereignty costs and uncertainty costs, the international community decided against harder legal rules. The section concludes that hard rules are unlikely to characterise the international monetary system in the years to come.
- The seventh section explores the future of bilateral surveillance. By discussing the social constructivist perspective of the IMF and the Fund’s track record as a setter of voluntary standards, it argues that instead of pursuing harder legalization the Fund should capitalise on its unique regulatory capabilities to overcome the stalemate in the supervision of monetary conduct.
This timeline shows the research framework:
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The different academic disciplines used in this paper offer a heterogeneous view in terms of existing literature. While there is an abundance of economic research on exchange rates, the same cannot be said for legal and political treatments. From the perspective of IL, “few books are available that deal with the legal framework underlying international monetary stability” (Thieffry 2008: 267). Gilles Thieffry blames this scarcity on the fact that “when dealing with this topic, it is difficult to avoid economics and politics, two subjects many lawyers avoid” (Thieffry 2008: 267). Scholars of IR also long ignored the subject for two reasons: exchange rates were deemed “too technical and too remote from the concerns of either the mass public or special interests” and there was a “tedious predictability of currency values under the Bretton Woods system [which] lulled most scholars into inattention” (Broz/Frieden 2002: 317). This changed only with the numerous currency crises in the 1980s. Since the 1990s, international monetary relations have become “extremely prominent in practice” – not least due to the crisis in Southeast Asia and the creation of the euro (Broz/Frieden 2002: 318). However, most research on the international monetary system and the IMF focuses on issues of conditionality and legitimacy, while exchange rate surveillance of non-borrowing countries receives scant attention. Nevertheless, this paper seeks – in drawing from all disciplines – to shed some light on a fascinating and highly relevant subject.
2. The role of law in monetary affairs
In the international monetary system – “the glue that binds national economies together” (Eichengreen 2008: 1) –, two legal principles collide. On the one hand states enjoy a high degree of sovereignty in their monetary policies. Premier Wen Jiabao refers to China’s “fundamental right to determine [its] own exchange rate” (quoted by Mussa 2007: 8). Even critics of China concede that maintaining a currency regime of its choice is a “legitimate matter of national sovereignty” (Goldstein 2005: 6). On the other, states are bound in their monetary policies by IL and the obligations it enjoins on them.
Even though the focus of this paper lies on the legal regime created in 1978, exchange rate surveillance needs to be appreciated in light of the demise of the highly legalized Bretton Woods system. This section shows how the evolution of the international monetary system heralded the revival of monetary sovereignty.
2.1 The principle of monetary sovereignty
Historically, control over money has long been considered essential to the notion of national sovereignty. Monetary sovereignty goes back to the exclusive right of coinage enjoyed by central governments which put an end to the coexistence of different currencies in circulation (Baltensperger/Cottier 2010: 913). For symbolic and economic reasons, the emergence of national currencies was closely related to the formation of the nation state (Herrmann 2010: 38). Today, monetary affairs, next to taxation, amount to “one of the last and most solid bastions of national sovereignty” (Baltensperger/Cottier 2010: 912). Even an ardent critic of state interference like Milton Friedman concedes that “there is probably no other area of economic activity with respect to which government intervention has been so uniformly accepted” (Friedman 1960: 8).
IL honours the fact that “the issue of a currency is an inherently national and sovereign act” (Proctor 2006: 1336). In a seminal ruling, the Permanent Court of International Justice stated in 1929 that “it is indeed a generally accepted principle that a State is entitled to regulate its own currency” (PCIJ 1929: 34). The currency to which a reference may be made in contracts is solely described by the law of the state, the “lex monetae” (Herrmann 2007: 3). This accords with domestic rulings which have confirmed that money, like tariffs and taxation, falls within the domestic jurisdiction of individual states – “a right to which other states cannot object” (Proctor 2005: 500).
In practice, monetary sovereignty establishes three rights for the national legislator: to issue currency that is legal tender within its territory; to determine the value of that currency; and to regulate the use of any currency within its territory (Gianviti 2006: 4). These tasks are usually carried out by a central bank with the privilege of issuing national banknotes as well as creating and holding monetary reserves (Proctor 2005: 57). Importantly, the scope of monetary sovereignty is both internal, as regards the operation of national monetary policy, and external, as regards exchange arrangements vis-à-vis other currencies (Hermann 2010: 39).
2.2 The need for cooperation in international monetary relations
Its domestic legislative remit notwithstanding, the exchange rate is an important price in the international economy. It expresses the relationship between the currencies of two countries and between its two economies – all goods, services and capital that move across national borders (Gold 1988: 1). Indeed, “for most countries, there is no single price which has such an important influence on both the financial world – in terms of asset values and rates of return, and on the real world – in terms of production, trade and employment” (Group of Thirty 1982: 10).
Like trade and investment, the two other dimensions of economic relations between states, monetary relations can take three shapes: cooperative, conflicting or non-existent. In the absence of isolationism, conflicts are unavoidable without cooperation (Lastra 2006: 346, footnote 2). It makes sense, therefore, that exchange rates should be subject to international agreement to avoid conflicts in the economic ties between states (Gold 1984: 1533).
In fact, international coordination of monetary policies has a long history (Baltensperger/Cottier 2010: 918). Central bank cooperation goes back to the 19th century (Lastra 2010: 345). And yet, the stability of the international monetary system until World War I “owed nothing to international legal agreements” (Simmons 2000a: 575).
Under the gold standard, countries linked their currencies to another and kept their reserves in gold or other currencies voluntarily. Balance of payments adjustment occurred automatically, as long as countries played along to the “rules of the game” (Barnett/Finnemore 2004: 51). While the extent to which the central banks followed the rules is disputed, the “miracle of the gold standard somehow managed to successfully reconcile stable exchange rates with high capital mobility” (Eichengreen/Garcia 2006: 397). However, this monetary arrangement was plagued by high inflation and unemployment levels which put enormous strains on the domestic economies. When World War I broke out, the gold standard collapsed over night.
In the interwar period, the limits of informal monetary cooperation became apparent. The end of World War I heralded “monetary chaos” (Proctor 2006: 1336). Attempts to re-establish the gold standard failed (Lastra 2006: 349). As trade contracted sharply and unemployment surged, the major economies employed unilateral monetary devices to divert economic stress abroad: competitive devaluation, multiple exchange rates, trade restrictions, subsidies and controls of various kinds (Lowenfeld 2008: 598). By the end of World War II, the international community came to accept that “while a state must be able to control its own currency and has a vital interest in its external value, the exchange value of the currency can also significantly affect the interests of other members” (Proctor 2006: 1336).
In order to avoid competitive currency depreciation, there was a need for “consensual rules to guide the re-opening of national payments systems and an institutional mechanism to monitor those rules and encourage monetary cooperation” (Pauly 2006a: 1). The view prevailed that a “free-for-all” exchange rate system would allow large nations to exploit their power at the expense of smaller nations and that individual nations would pursue objectives not consistent with one another (Cooper 1975: 65). Never again were the monetary aberrations of the 1930s to be repeated. Rather, the states stood to gain reduced currency volatility, stability of domestic monetary conditions and the reduction of international trade conflicts (Broz/Frieden 2002: 337).
2.3 Limiting monetary sovereignty: the Articles of Agreement
The institutional answer to the need for monetary cooperation was the creation of the IMF. When the Articles of Agreement came into force in 1945, an international legal regime governed the monetary conduct of states for the first time (Lowenfeld 2008: 576). Up to that point, there existed no multilateral treaty and virtually no customary international law in relation to exchange rates (Gold 1988: 2). Like activities on the sea and diplomatic relations among states, money became subject to the broader norms and principles of IL (Simmons 2000a: 578).
By joining the IMF’s founding treaty, the members accepted its obligations and limited, to that extent, their monetary sovereignty. In exchange, they enjoyed the benefit of other members also limiting their sovereignty for the sake of international cooperation (Gianviti 2006: 3). Full monetary sovereignty now existed only in those countries that were not part of the IMF. However, it must be noted that participation in the IMF remains voluntary. According to Art. XXVI:1, any member may withdraw from the Fund at any time. The rules of monetary conduct that arise from the Articles concern only the signatory states (Proctor 2005: 558) – and do not express universally binding duties.
While their obligations appear modest today, the Articles of Agreement were a significant departure “in view of the jealousy with which states have traditionally guarded their monetary autonomy” (Pauly 1997: 11). And yet, although the authority over exchange rates granted to the Fund was “unprecedented” (Gold 1988: 48), its influence as a monetary institution today looks quite different from what the founders set out to create in 1945. The rise and fall of the IMF as a monetary institution helps to explain the softness that has characterised the law on exchange rates since the collapse of the Bretton Woods system.
2.3.1 Unprecedented legality: 1945 to 1971
The Bretton Woods conference saw the creation of two major financial organisations. But unlike the World Bank, the IMF was not planned as a development agency (Leckow 2008: 286). Against the backdrop of the Great Depression and its monetary woes, the Fund was designed to sustain a peaceful political order by fostering international trade and macroeconomic stability (Dodge 2006: 1). Its objective was “the maintenance of fixed, unitary, and non-discriminatory exchange rates that carried the endorsement of the international community as expressed in decisions of the IMF” (Gold 1984: 1536).
The par value system at the heart of the original Art. IV was an attempt to combine stability and elasticity – the advantages of a system of fixed exchange rates with that of flexible rates without the disadvantages of either (Rittberger/Zangl 2006: 160). While the value of their currencies was determined by market forces, the members agreed to maintain their currency at an agreed par value which was fixed but adaptable on request. To a degree, the system was self-enforcing. The Fund’s role was to monitor the orderly adjustment of the balance of payments and to assist a member with temporary loans if it needed funds to finance necessary interventions.
Moreover, the Articles restricted the movement of international capital flows to insulate the national capital markets. In 1945, it was understood that “sharp changes in capital flows were costly. Changes in capital flows can induce changes in trade flows. And to bring about large changes in trade flows often requires not only a reallocation of resources, but also in some cases sharp falls in national output” (King 2006: 4). Therefore, the convertibility requirement of the Articles foresaw only convertibility in the current account, while “the architects of Bretton Woods essentially took for granted the indefinite maintenance of capital controls” (Eichengreen/Garcia 2006: 397).
In practice, the system worked well only for a few years. It came fully into effect only when the European members achieved full convertibility around 1960. And even then, the system was only partially adhered to. Some members preferred to violate their obligations for their national benefit. However, the members “never abandoned the idea that they remained bound by a legal duty to collaborate on exchange rate matters” (Pauly 2006a: 3).
The greatest challenge to the par value system appeared in the late 1960s. With the increase in unregulated capital flows, governments lost their ability to maintain stable exchange rates (Rittberger/Zangl 2006: 161). Experience showed that to have sufficient bite, capital controls needed to be so tough that they harmed trade financing (Andrews/Willett 1997: 483). The fixed exchange-rate mechanism offered the markets a one-way speculative bet. The last of the fifteen changes in the par values of the members of the Organisation for European Economic Cooperation (OEEC) took place in 1961, as governments “consciously tried to avoid exchange-rate changes” (Schaefer 2006: 202).
The crumbling faith in the par value system showed that the balance of payments adjustment process was not working smoothly. In the face of enormous war costs and a deteriorating competitive position, the US lost its willingness to “run a large trade deficit to ensure liquidity in the international monetary system, to promise to convert foreign-held dollar reserves into gold and to pursue anti-inflationary policies to keep the exchange rate system stable” (Schaefer 2006: 201). On 15 August 1971, US President Richard Nixon terminated gold convertibility and decided to float the rate of the USD (Lowenfeld 2008: 625).
2.3.2 Reforming the Articles: 1971 to 1978
In 1971, the IMF, the US and the nervous leaders of Western Europe “tried to pick up the pieces and repair the system, each looking to the others to take the painful decisions of currency devaluation or revaluation” (Lowenfeld 1983: 388). The Smithsonian Agreement, established on 18 December 1971 and hailed by US President Nixon as “the most significant monetary agreement in the history of the world” (quoted in Lowenfeld 1983: 389), proved unsustainable in economic and legal terms. Described as a “par value system on life support” (Lowenfeld 2010: 582), a system of fixed exchange rates with wider margins no longer served the interests of the large economies. While the IMF was not finished – most of the original Agreement remained relevant –, its legal exchange rate regime appeared painfully obsolete.
However, many states wished to “return to legality” by amending the Articles of Agreement to reflect the reality of floating exchange rates (Lowenfeld 2008: 631). When the US took the lead in trying to restore international monetary legality, France favoured a return to fixed exchange rates under a rule-based system (Pauly 2006a: 10). By contrast, the US wished to create a flexible regime that would “foster adjustment through regular consultations but allow individual countries themselves to create the conditions for attaining domestic macroeconomic objectives” (Lombardi/Woods 2007: 7). They regarded the markets as sufficient in size, strength and scope to determine exchange rates (Gold 1988: 7).
In the end, the US got its way. Nonetheless, it agreed on maintaining a “stable system of exchange rates” to appease France (Pauly 2006a: 12). At its first meeting ever in November 1975 in Rambouillet, the G-7 set the course for the formal amendment process of the Articles. Its declaration expressed the intention to “counter disorderly market conditions, or erratic fluctuations, in exchange rates” (G-7 1975: N. 11). The Second Amendment, now officially allowing the free choice of exchange arrangements, came into force on 1 April 1978.
2.3.3 Back to sovereignty: 1978 onwards
For the IMF, this was a mixed outcome. On the one hand, the international monetary system returned to legality after seven years of uncertainty. On the other, the Fund had little say in the new arrangement. Critics regarded the Second Amendment as an “adaptation of the legal regime to the actual state of affairs (in particular with regard to floating exchange rates) and not in any real sense a cure or even a prescription for a cure of the system's ills” (Lowenfeld 1983: 394).
In legal terms, the Second Amendment marked a radical change for the IMF. Though the Fund maintained its responsibility to provide international liquidity as well as technical assistance, it lost its importance in monetary affairs as authority shifted back to the members. The new Art. IV abolished the par value system, deprived gold of its former monetary role and established a system of floating currencies. Indeed, upon leaving the gold standard and fixed exchange rates, “there was very little left for a regulatory and legal approach to monetary affairs” (Baltensperger/Cottier 2010: 927). This prompted the economist Robert Triffin to call the amended Articles “more worthy of a slapstick comedy than of a solemn treaty defining a new international monetary system” (Triffin 1976: 45). International lawyers were uncertain what to make of the new rules. In a review of a book on the new legal arrangement (Rules of the Game by Kenneth Dam), Andreas Lowenfeld wondered
what Professor Dam would come up with as rules of the international monetary game. I have been anxiously looking around for sources of black-letter law – for rules, in other words, as contrasted with factors, considerations, or illustrations. The game is still there, but the rules are more elusive than ever (Lowenfeld 1983: 380).
However, the members – bearing in mind the need for international cooperation – did not deprive the Fund completely of its responsibilities for the international monetary system. There was no intention to go back to the days of monetary anarchy. In a “remarkable acknowledgement of the principle that exchange rates should be regulated by international law” (Gold 1988: 7), the members tasked the IMF with two new functions which, on paper, expanded its role as a monetary institution: overseeing the international monetary system in Art. IV:3(a) and monitoring national exchange rate policies by way of “firm surveillance” in Art. IV:3(b).
The new responsibilities put the Fund in a difficult situation. The members had taken back their sovereignty, and at the same time refused to provide the IMF with the necessary instruments to fulfil its new task. This “contradictory element” (Lombardi/Woods 2007: 7), not yet resolved by the IMF membership, characterises the vagueness of the IL on monetary conduct to this day. In a more positive reading, Louis Pauly interprets this development as a “continuing attempt by the Fund’s most powerful member-states to find the golden mean [...] between binding monetary rules and unbridled national discretion”; the “normative quest” for cooperation, he claims, “survives unbroken since 1944” (Pauly 2006a: 1).
2.4 The IMF in today’s international monetary system
After World War II, a powerful IMF seemed the right response to the turmoil of the interwar years. Since 1945, however, the environment the IMF was supposed to regulate changed markedly. Due to tectonic shifts in the international monetary system, the member no longer believed that a highly legalized IMF would serve their interests. Four developments in particular have challenged the IMF’s ability to preserve monetary stability.
First, the prevalence of money with no inherent value (called fiat money). After Nixon had severed the link between currencies and a commodity, money lost its inherent value. The members were free to circulate money in the form of irredeemable debt obligations, thereby greatly increasing their national monetary autonomy (Steil 2007: 203). While instrumental for advancing growth and the flexibility of domestic monetary policy, this change paved the way for an increased volatility of the international monetary system.
Second, the dominance of the dollar. Contrary to what the abolition of an officially dollar-based system might suggest, “the demise of the Bretton Woods arrangements actually implied transition to a full dollar-based global economy, with the advantage that the United States had no commitments on gold convertibility” (Pattainak 2007: 316). Decades after the former French President Valéry Giscard d’Estaing denounced the “exorbitant privilege” the US had in providing the global reserve currency, the world turned to the dollar for stability and liquidity. In 2009, the USD was still used in 86 per cent of foreign exchange transactions and in 63 per cent of foreign reserves (McKinsey Global Institute 2009: 14). By contrast, the IMF’s international reserve asset (called SDR) failed to find acceptance – which is unlikely to change in the upcoming multipolar reserve system (Eichengreen 2011b).
Third, the fragmentation of exchange arrangements. The end of the obligation to peg saw a variety of exchange regimes evolve. To enjoy the flexibility that comes with a floating exchange rate, most developed countries abandoned their pegs, whereas many developing economies continued to link their currency to the USD or currency baskets to maintain currency stability. The appearance of currency unions further hampered the IMF’s task. As of 2009, the IMF members operate 29 hard pegs, 78 soft pegs, and 75 floating rates; in total, the IMF recognises nine different exchange arrangements (IMF Revised Classification 2009: 4).
Finally, the rise of financial markets. With the gradual opening up of the capital account, financial markets became larger and deeper, in many cases dwarfing official flows (Dodge 2006: 3). Between 1980 and 2007, cross-border capital flows grew at an annual rate of 13 per cent, from 0.4 to 10.9 trillion USD (McKinsey Global Institute 2011: 27). Countries could now finance large and long-lived current account deficits and surpluses through the markets without turning to the IMF (Mussa 2007: 37). The members lost their main incentive for listening to the Fund: where pegged exchange rates once served as the “main transmission belt for responsive policy actions, now-burgeoning international capital markets increasingly provided the actual stimulus for adjustment” (Pauly 2006a: 9). In addition, capital mobility undermined the efficiency of exchange rate management by eroding capital controls and increasing the cost of central bank interventions.
In combination, flexible exchange rates, independent monetary policies and easy borrowing from booming markets produced a “combustible mix” (Pauly 2009: 959) which limited the influence of the IMF. As more and more states enjoyed the fruits of monetary independence, the practice of bilateral surveillance bore little resemblance to the vision set out in the Second Amendment. Far from overseeing all members equally, the Fund’s sway was restricted to countries it could impose its conditions on – which made the IMF’s involvement highly contentious. After its alleged mishandling of a number of currency crises, many observers criticised what was seen as an attempt to “strong-arm countries into conformity with dominant behavioural norms” (Pauly 1997: 10).
As a result, the responsibility for the international monetary system slipped away from the Fund. Instead, the major economies took monetary affairs into their own hands. Domestically, they established new mechanisms for constraining monetary policy, such as independent central banks and inflation targets (Walter 2010a: 16). In the international realm, they set up new institutions like the G-7 to coordinate their monetary and exchange rate policies. Thereby, “monetary policy was effectively freed from indirect multilateral constraint” (Walter 2010a: 16). Although it was initially understood that the IMF would cooperate with the new institutions, a division of labour emerged. In agreements like the Plaza Accord in 1985 and the Louvre Accord in 1987, the major economies focused on the valuation of the dollar, while the IMF was reduced to a provider of information. The responsibility to signal necessary balance of payments adjustments shifted from the IMF to cross-border financial markets.
At the turn of the century, this left the Fund in a dire state. While the IMF was forced to cut staff, developing countries started to amass large reserve holdings to insulate against its intervention. If not in “a deep slumber”, the Fund appeared “drowsy” and its mandate “obscure” (King 2006: 3). In early 2008, the US was considering if the IMF was worth keeping, “with the weight point toward no” (Griesgraber 2009: 179). It took the impact of the global financial crisis to put the IMF back on the map as the G-20 endowed the Fund with a renewed mandate to oversee systemic stability (G-20 2008: N. 89). Nonetheless, macroeconomic policy coordination “remained both necessary in principle and elusive in practice” (Pauly 2009: 960).
To sum up, the Second Amendment reversed the high degree of legality of the Bretton Woods arrangement. However, the chaos of the interwar period had left its mark. The members still wanted the IMF to oversee their monetary conduct and the international monetary system – without endowing it with the necessary powers. This put the Fund in a conflicting position. It was still supposed to police its members, regardless of their economic conditions. But as the world’s major economies had regained their monetary sovereignty, its effective mandate became unclear.
3. Bilateral surveillance of exchange rate policies
The overall objective of the IMF – to promote international monetary and financial stability – never changed. What did change, however, was the IMF’s role after the breakdown of the Bretton Woods system. In total, the Articles establish three powers for the Fund:
illustration not visible in this excerpt
In the first decades of its existence, the Fund performed primarily a regulatory function. Its tasks revolved more and more around its financial and advisory powers only after the Second Amendment in response to periods of instability triggered by the growth in private capital flows (Hagan 2010b: 41). However, the drastic transformation of the regulatory function did not affect the first regulatory power, the jurisdiction over international payments to make currencies convertible (Art. VIII), which remained unchanged. The novelty was the second regulatory power, surveillance, which replaced the par value system set out in the original Art. IV. Specifically, the new Art. IV provided the Fund with two instruments for overseeing domestic and international monetary affairs: bilateral and multilateral surveillance of exchange rate policies (Hagan 2010a: 957).
IMF surveillance has two principal goals (Boughton 2001: 136). The first is to “identify and discuss differences in interests and perspectives between the country and the international community”. The second is to “examine economic developments and prospects objectively, abstracting as much as possible from political goals and constraints”. To achieve these diverse objectives, the Fund produces a number of surveillance documents, ranging from the World Economic Outlook (WEO), a survey published twice a year about global economic developments, to Global Financial Stability Reports (GFSR), semi-annual assessments of global financial markets. Like the Fund’s more public functions of financial and technical assistance, they are almost all voluntary, although the Fund might link financial assistance to the fulfilment of specific objectives set out in a report. Figure 3 shows how the publications vary in spatial focus, legal obligation and subject matter:
illustration not visible in this excerpt
Only one vehicle of surveillance is mandatory across the entire membership: bilateral Art. IV consultations which differ considerably from other economic reports produced by private or public institutions due to their legal quality. Bilateral surveillance is a jurisdictional function that involves a degree of discretion on part of the Fund (Lastra 2006: 399).
Originally, Art. IV consultations were carried out during the Bretton Woods years to monitor progress on current account convertibility. Since the Second Amendment, they evolved into a full-fledged assessment of the macroeconomic policies of a member in light of his obligations stemming from the Articles. The function of Art. IV surveillance can best be explained with a metaphor in which Louis Pauly compares the supervision of global finance with the construction of a house:
Constructively interacting national macroeconomic policies are the foundations, and a modicum of convergence in national regulatory standards is the plumbing. Central bankers, bank supervisors, securities regulators, and accounting standards boards have a large role to play in reinforcing the plumbing. All of their work is for nothing, however, if the central organs of government responsible for macroeconomic policy in an expanding array of powerful states move in distinctly different directions. Such a movement would crack the foundations of ‘global’ finance, and no superior exists to fix it (Pauly 1997: 142).
3.1 The original bilateral surveillance regime
To put bilateral surveillance into practice, the members agreed on a number of rules to guide both themselves in their policies and the Fund in its supervision. The resulting legal arrangement (what is referred to as the “bilateral surveillance regime” in this paper, see the overview in Appendix 2 in section 9.1) consists of three parts: the amended Art. IV called “Obligations Regarding Exchange Arrangements” which replaced the original Art. IV; a decision by the Executive Board which makes the provisions of Art. IV operable; and Art. XXVI which contains the theoretical enforcement mechanisms of the Fund.
This section takes a closer look at the original surveillance regime which governed Art. IV consultations between 1978 and 2007. While only descriptive in nature, it is necessary for the application of the legalization concept in section 4. For readability’s sake, the legal quotes are kept to a minimum. The complete legal provisions are reprinted in section 9.3.
3.1.1 The amended Article IV
The amended Art. IV contains the principal obligations for both the members and Fund regarding exchange rates. It is the key provision in ensuring the stability of the global exchange rate system. Unless the Articles are amended again, it applies to all members, at all times, whatever their exchange arrangements may be (Gold 1988: 89). In order to achieve a “stable system of exchange rates”, it sets out three objectives: a member should not resist an adjustment required by underlying conditions; its domestic policies should foster economic and financial stability; and it should avoid policies designed to interfere with the adjustment process or gain an unfair competitive advantage (IMF Legal Framework 2006: N. 3).
Most pertinent to the bilateral surveillance of exchange rates are three provisions: the free choice of exchange arrangement, Art. IV:2(b); general obligations of members, Art. IV:1; and surveillance over exchange arrangements, Art. IV:3. They are discussed in this order because a legitimate exchange arrangement (peg or float) is the precondition for legitimate exchange rate policies (the actual policy decisions).
a) Free Choice of Exchange Arrangement, Art. IV:2(b)
The main reason why the par value system collapsed was the desire of the major economies to regain freedom over their currency decisions. In consequence, the amended Art. IV concedes considerable autonomy to the members in regard to their exchange arrangement. As per Art. IV:2(b) of the Articles, the only prohibited arrangement is a peg to gold, reflecting the intention of the Second Amendment to reduce the role of gold in the international monetary system (IMF Legal Framework 2006: N. 11). All other exchange rate systems established by IMF members are allowed, from choosing a foreign currency as legal tender to currency board arrangements and from fixed to floating exchange rates (Herrmann 2010: 40).
However, this freedom is not unlimited. Lowenfeld points out that Art. IV:2(b) does not mean no rule at all (Lowenfeld 2008: 634). Art. IV:2(b) cannot be read in isolation, it must be considered in light of the other provisions of the Articles, specifically the obligations imposed on the members by Art. IV:1. Therefore, a member’s exchange arrangement is only permitted as long as it does not breach its other obligations under the Articles (IMF Legal Framework 2006: N. 13).
b) Obligations of members, Art. IV:1
Establishing the obligations in regard to exchange rate policies, Art. IV:1 is considered the most complex of the Fund’s provisions (IMF Legal Framework 2006: N. 16). It consists of three parts: the preamble and a general obligation as well as four specific obligations. Out of these, exchange rate manipulation deserves closer scrutiny.
aa) Preamble and general obligation
While containing no obligations, this section of Art. IV:1 provides a framework for the following, more specific obligations. By setting forth the “purpose” and “objective” of the international monetary system, the preamble identifies the broader economic benefits of Art. IV:1. The assumption is that adherence to its obligations enhances the functioning of the international monetary system (IMF Legal Framework 2006: N. 17). Importantly, the preamble speaks of the purposes of the international monetary system, not of the Fund. This reflects the shift in objective from achieving a stable exchange rate to achieving a stable exchange rate system. The function of the preamble is to assist the interpretation of the obligations regarding exchange rate arrangements (Mercurio/Leung 2009: 1271-1272).
The same applies to the general obligation to “collaborate” with the Fund. This provision stresses the collaborative nature of the surveillance relationship from the very beginning (IMF Further Considerations 2007: N. 29), whereas the degree of collaboration necessary to satisfy the general obligations remains vague (Mercurio/Leung 2009: 1273).
bb) Specific obligations
The four specific obligations of Art. IV:1 differ considerably in scope and bindingness. In particular, each member shall
(i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances;
(ii) seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions;
(iii) avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members; and
(iv) follow exchange policies compatible with the undertakings under this Section.
The obligations (i) and (ii) are positive in character. Formulated in soft terms, they are “more hortatory than peremptory” (Gold 1984: 1542), as opposed to the negative obligations in (iii) and (iv), arguably considered “hard obligations”. This difference goes back to the Fund’s juridical scope, which is greater in external policies than in domestic ones (Lastra 2010: 7). The formulation of the obligations was driven by the fact that “members should not have to give up a significant degree of sovereignty with respect to policies that, while they may have an international impact, are of domestic nature” (IMF Legal Framework 2006: N. 3).
The choice of verbs (endeavour, seek to promote, fostering, follow) illustrates the “labour pains” of the origins of this provision (Lastra 2010: 8). This is particularly the case with (i) and (ii). According to Edwards, “public statements of U.S. and French officials involved in the drafting of the new Art. IV indicate that neither in their preparatory work nor during the negotiations did they develop concrete examples of conduct that would be treated as violating subsections (i) and (ii)” (Edwards 1976: 737). Similarly confusing is obligation (iv). As the IMF recalls, at the time of its adoption there was uncertainty as to its meaning. There is no evidence whether “exchange policies” are broader than “exchange rate policies” and how this provision was to supplement the other obligations (IMF Legal Framework 2006: N. 35-37).
Hence, the bindingness of (i), (ii) and (iv) is disputed. Proctor asserts that “it is only necessary to read these provisions in order to realise that they do not create any obligations of a character which are meaningful in law” (Proctor 2005: 62). He considers the entire Art. IV:1 of very limited legal content, “aspirational, rather than legally enforceable” (Proctor 2006: 1338). Gold agrees that while technically binding obligations, the softness of (i) and (ii) makes it impossible to find that a violation of them has occurred (Gold 1988: 105).
cc) Exchange rate manipulation
The most specific and arguably most binding obligation is (iii). However, the concepts and definitions at its heart are highly problematic. What actions constitute currency “manipulation”, the existence of which is itself called into question? A full discussion of these matters, particularly in economic terms, will be presented in relation to China’s policies in section 5. For now, the focus lies on the legal problems that arise.
One of the main difficulties in defining manipulation is that intervention itself is common in the international monetary system. Semantically, “manipulation” means to manage or influence by exercise of one’s abilities or skills (Edwards 1976: 743). It does not inherently carry a negative connotation. Whether it is good or bad depends on its objectives and effects. Since most countries manage their exchange arrangements to some degree, on the grounds of too broad a definition “virtually all countries could be considered to be ‘manipulating’ their exchange rates almost all of the time” (Mussa 2007: 13).
The clearest evidence of exchange rate manipulation is a “disproportionately large devaluation designed to secure a competitive advantage over neighbouring states with no broader objective in view” (Proctor 2005: 573) – such as Sweden’s one-time devaluation of 16 percent in 1982 (Lowenfeld 2008: 635). Most examples, however, are not that clear-cut. When China maintained a stable exchange rate during the Asian crisis in 1997-8, its action was judged positively, as it had not sought to gain an unfair competitive advantage (Mercurio/Leung 2009: 1280). Five years later, similar policies sparked harsh criticism.
Ultimately, three questions must be answered (Gold 1988: 109): is an active behaviour on the part of the alleged manipulator required? Is a movement of the exchange rate necessary? And which role do the intentions of a country play?
In response to these difficulties, Art. IV:1(iii) divides manipulation into two elements. To establish a breach of its obligations, a member must fulfil an objective element (“manipulation”) and a subjective element (“in order to” achieve one of two reprehensible goals) (Herrmann 2010: 41). Admittedly, this is not of much help, as “manipulation” and “unfair competitive advantage” still constitute nebulous terms. In addition, most of the problematic developments connected to exchange rates are the result of domestic policies, whereas Art. IV:1(iii) concerns external policies – and extending Art. IV:1(iii) to external policies would make (i) and (ii) superfluous (Gold 1988: 109).
The clarification of Art. IV:1(iii) by the IMF Legal Department is not helpful. There are, it says, “different ways” in which a member could manipulate its exchange rate – which “would not necessarily require that official intervention – whatever its form – result in the movement of the exchange rate” (IMF Legal Framework 2006: N. 34a). Bryan Mercurio and Celine Leung call this definition so broad it is “virtually unworkable” (Mercurio/Leung 2009: 1278).
c) Surveillance over exchange rate policies, Art. IV:3
Art. IV:3 is the legal basis for the Fund’s responsibility of surveilling the obligations of Art. IV:1. Surveillance is a “process of dialogue and persuasion centred on issues of external stability, covering exchange rate policies and relevant domestic policies” (IMF Further Considerations 2007: N. 2). It is intended to “help head off risks to international monetary and financial stability, alert the members to potential risks and vulnerabilities and advise them on needed policy adjustments” (IMF Surveillance Factsheet 2011: N. 1). In its structure, Art. IV:3 reflects the Fund’s dual oversight function – over the international system and individual member countries. Art. IV:3(a) is concerned with the international monetary system and establishes the basis for the Fund’s multilateral surveillance activities, albeit without bindingness. By contrast, Art. IV:3(b) lays the foundation for the bilateral surveillance of IMF members.
In principle, bilateral surveillance is a universal system of peer review and oversight (Lombardi/Woods 2008b: 2). According to Art. IV:3(b), all members must submit to surveillance, regardless of their exchange arrangement; they must all supply information and they must all enter into consultation with the Fund (Lowenfeld 2008: 637). These consultations, carried out at 12- to 18-month intervals, are at the core of the bilateral surveillance activity. At the end of the consultation, the IMF mission produces a comprehensive report on the macroeconomic conditions, policies, and outlook of a member (Lavigne/Vasishtha 2009: 6). In their reports, IMF staff are expected to provide descriptions of the country’s exchange rate arrangement, an appraisal of its appropriateness with underlying policies and an assessment of the exchange rate level (Aylward 2007).
The schematic overview of the bilateral surveillance process in Appendix 3 in section 9.1 highlights three key takeaways:
- Art. IV consultations are bilateral – they are based on extended discussions with national policymakers whose views are given ample space in the published staff documents.
- There is no single Art. IV report by the IMF. Instead, various documents are produced by the staff and the Board which may reflect opposing views.
- Art. IV consultations work through a number of channels. There is direct contact with the national authorities, but also indirect effects on investors and the private sector – and other surveyed countries.
3.1.2 The 1977 Decision on exchange rate surveillance
In order to flesh out the provisions on bilateral surveillance, Art. IV:3(b) requires the Executive Board to draw up “principles” for bilateral surveillance. For this purpose, the 1977 Decision came into force with the Second Amendment on 1 April 1978 and served as the legal foundation for 30 years of IMF surveillance (Herrmann 2010: 42).
To come to terms with the uncertainty of the new monetary system, principles had to be found to allow close surveillance irrespective of the members’ exchange arrangements. This resulted in a “minimalist” approach to define surveillance that reflected the constraints faced at the time (IMF Preliminary Considerations 2006: N. 18). Published shortly after the breakdown of the Bretton Woods system, the 1977 Decision focused exclusively on the surveillance over exchange policies (IMF PIN 07/69 2007).
The 1977 Decision contains two relevant provisions: general principles and principles for the guidance of members’ exchange rate policies (PGMs) as well as principles for the guidance of the Fund (the “indicators”).
a) General principles and PGMs
The general principles of the 1977 Decision posit that it is not necessarily comprehensive; subject to reconsideration in the light of experience and concerned directly only with Art. IV:3(b). The 1977 Decision then goes on to list the principles to which the members need to adhere to in their exchange rate policies, called PGMs in the parlance of the IMF.
Principle A simply repeats the provision of Art. IV:1(iii) against currency manipulation, as it was feared that any paraphrase might suggest more obligation than intended (Gold 1988: 329). Principle B and C both deal with foreign exchange market intervention, which was understood to be the premier tool of exchange rate policy (Mussa 2007: 19). Principle B specifically addresses floaters, encouraging them to intervene for the stabilization of their exchange rate to avoid erratic exchange rate fluctuations. Of the three principles, this PGM has provoked the most debate and least agreement. It is formulated to avoid any implication of a “right” exchange rate (Gold 1983: 467). Principle C is again hortatory, urging the members to consider the impact of their interventions on other members.
From a legal point of view, the principles merely provide guidance. A member’s neglect of a principle does not automatically constitute a breach of obligation – with the exception of Principle A which mirrors the obligation in Art. IV:1(iii) (Gold 1983: 455). For the other two principles, there is no evidence they ever actually constituted obligations (IMF Legal Framework 2006: N. 44).
The third section of the 1977 Decision contains a number of developments that “might indicate the need for discussion with a member” if it pursues policies inconsistent with the obligations arising from Art. IV:1 (Lowenfeld 2008: 638). The purpose of these developments is to guide the Fund in its surveillance of exchange rate policies. Importantly, their interpretation is not intended to be mechanistic, but rather judgemental (Goldstein 2005: 3). In other words, when indicators are triggered, it does not necessarily follow that a member is not observing a principle (IMF Further Considerations 2007: N. 53). Rather, it constitutes the first step to an enquiry by the IMF.
The indicators can be divided into two groups. The first four developments focus on policies that appear designed to engineer a misaligned exchange rate. The last two are concerned with outcomes suggesting the existence of exchange rate misalignment or balance of payment disequilibrium (IMF Further Considerations 2007: N. 55). However, Mussa finds it remarkable that they make explicit reference to the balance of payments only in the qualifying sense “for balance of payment purposes” in (ii), (iii a), (iii b) and (iv) and not at all in (v) and (vi). Similarly, there is only one reference to the exchange rate in (v) (Mussa 2007: 22).
Nevertheless, Lowenfeld regards the 1977 Decision as a significant expansion of the Fund’s authority. The 1977 Decision, he argues, authorises the Managing Director to raise almost any matter of the member’s economic policy that has effect on its exchange rate or on the international economy (Lowenfeld 2008: 639).
In short, the original bilateral surveillance regime reflected the uncertainty of the years after Bretton Woods. Defended as political compromise, Art. IV is a “compound of obscure expressions” (Gold 1988: 112). While the 1977 Decision’s scope appears sufficiently broad due to the indicators, its leverage is curtailed by the hesitant tone and the limited onus on the members. The only truly binding obligation – the avoidance of currency manipulation – is defined so vaguely it is basically impossible to enforce. But even though the legitimacy of the 1977 Decision as a basis for surveillance was called into question soon after its ratification, reform materialised only after 30 years.
3.2 The reformed bilateral surveillance regime: the 2007 Decision
Reforming the rules for bilateral surveillance proved an arduous task. For two decades, reviews were restricted to minor and procedural provisions. While the G-8 called on the IMF to strengthen its monitoring role in 1999 (G-8 1999a), it took another six years until the then Managing Director Rodrigo De Rato launched his “Medium-Term Strategy” (MTS) to reform surveillance (Hagan 2010b: 41). The IMF lamented that the 1977 Decision “embodies only a small part of the best practices in surveillance”, “discusses only as subset of members’ policies covered by Art. IV” and “says virtually nothing about the role of the Fund in the conduct of surveillance” – which all in all led to a “striking gap” between its language and the reality of surveillance (IMF Further Considerations 2007: N. 3).
The IMF welcomed the adoption of the 2007 Decision on 15 June 2007 in boastful terms. The reform, it says, is the “culmination of a long and thorough effort to analyse gaps in the 1977 Decision, to distil the best practice of surveillance, and to crystallize a common vision of modern surveillance” (IMF PIN 07/69 2007). At first glance, this loftiness is surprising. The 2007 Decision resembles its lacklustre predecessor in many ways. Nonetheless, it contains some much-needed clarifications. First, the 2007 Decision introduces a new PGM for the avoidance of exchange rate policies resulting in external instability. The concept of exchange rate manipulation is then further explained and the indicators modernised, including “fundamental misalignment” of the exchange rate as a key trigger (US Treasury 2008: 2).
By way of domestic law analogy, the 1977 Decision can be regarded as the “constitutional framework” for surveillance, whereas the 2007 Decision ensures its effective implementation (Leckow 2008: 290). In terms of structure, the 2007 Decision mirrors the 1977 version by including a preamble and principles for the guidance of the Fund; the PGMs and the indicators; and procedures and an annex to conclude it.
 There is some confusion as to the correct denomination of the Chinese currency. Renminbi (RMB), the name used in this paper, is the formal term, referring to the legal tender. Yuan is the actual unit, used as the more colloquial expression (Wall Street Journal, 21 June 2010).
 The relevant legal and economic concepts used in this paper are explained in the Glossary, section 9.2.
 Unless otherwise stated, “Art.” henceforth always refers to the Articles of Agreement of the IMF as per the Second Amendment of the Articles that took effect on 1 April 1978.
 Changes to the constitutional charter of the IMF are called amendments. So far, they happened five times. On 28 July 1969, the First Amendment introduced a monetary reserve asset called the special drawing rights (SDRs). The Second Amendment which abolished the par value system became effective 1 April 1978. The Third Amendment of 11 November 1992 provided for the suspension of certain rights of members not fulfilling their obligations. The Fourth Amendment (10 August 2009) established a special one-time allocation of SDRs. The Fifth Amendment (18 February 2011) expanded the Fund’s investment mandate. References to the “original Articles” in this paper are not confined to the original version (1945 to 1969), but include the First Amendment (1969 to 1978). “Articles” or “amended Articles” refers to the Articles after 1978. For the full references to all IMF documents used in this paper see the Bibliography.
 In analogy to a public firm, the Fund’s three decision-making organs can be described as “the board of directors” (the Executive Board), “the shareholders” (the Board of Governors) and “the chairman of the board” (the Managing Director) (Lastra 2006: 376). A stylised view of IMF governance is contained in the Appendix 1 in section 9.1. More information can be found on the IMF website <http://www.imf.org/external/about.htm>. For an extensive treatment of IMF governance see Lamdany/Martinez-Diaz 2009.
 This paper is written in British English. However, the concept of “legalization” and the adjective “legalized” maintain their American spelling due to their formulation by American scholars.
 The most important treaties on the international law of money are Lowenfeld 2008, Lastra 2006 (focusing on the public aspect) and Proctor 2005 (focusing on the private aspect). The scholar of reference on the law of exchange rates is Joseph Gold, in particular Gold 1988. The best source for a history of the IMF are the Fund’s own historians, such as Boughton 2001. The political economy of exchange rates is explored by Eichengreen 2008, Kirshner 1997 and Cohen 2010. For the issue of currency manipulation, the most pertinent articles are Herrmann 2010, Mercurio/Leung 2009 and Mussa 2007. Further references and reading suggestions are included in the relevant sections.
 In this section, sovereignty is defined in legal terms: “The right of a country to take decisions without the necessity for the consent of another country” (Gold 1988: 3). Note that definitions of sovereignty differ considerably between legal understandings and political or economic concepts. Critics denouncing the “waning of monetary sovereignty” (Treves 2000: 112) due to the influence of global capital markets refer to factual independence, not legal independence (Herrmann 2007: 5). Factual sovereignty costs will be explored in section 6.
 Lastra traces monetary sovereignty back to the writings of Machiavelli, Bodin and Hobbes (Lastra 2006: 6).
 The notable exception being the euro zone where 16 states have transferred their monetary rights to the European Central Bank. Lastra calls this “the most clear example of consensual limitation of monetary sovereignty” (Lastra 2006: 27).
 Such rulings include “The Emperor of Austria v. Day and Kossuth” by the English Court of Appeal in 1861 and “Juillard v. Greenmann” by the US Supreme Court in 1884 (Waibel 2010).
 As a legal concept, the notion of external monetary sovereignty is not without critics. The former IMF economist Michael Mussa calls it “nonsense” and “a logical absurdity” (Mussa 2007: 8). He argues that both nations must symmetrically possess the same sovereign right to set the exchange rate since it is a value between two currencies. However, Mussa confuses the “right” with the “manifestation” of the right (Mercurio/Leung 2009: 1269). The fact that a right of a nation conflicts with another’s does not necessarily deprive both nations of their respective rights. The impossibility for both nations to achieve their respective desirable exchange rate is an insufficient limitation to negate the existence of the state’s right to determine its currency.
 The international gold standard was a monetary arrangement between roughly 1870 and 1914. Currencies were fixed in their value against gold and central banks vowed to exchange currency for a set parity (Lastra 2006: 348).
 Other monetary “law-setters” include the World Bank and its affiliates, the Bank for International Settlements, the Paris Club, the Group of Ten, the Group of Seven and related groups. An overview in: Lowenfeld 2008: 749.
 The IMF currently has 187 members (as of June 2011). The member list is available online: <http://www.imf.org/external/np/sec/memdir/members.aspx>.
 “A treaty does not create either obligations or rights for a third State without its consent“, Art. 34 of the Vienna Convention on the Law of Treaties, 1969.
 When did the Bretton Woods system end? De facto, the day US President Richard Nixon terminated the Gold parity in 1971. De jure, with the Second Amendment in 1978 (Lastra 2006: 29).
 Specifically, Art. IV of the original Articles established a parity of 1 USD = 0,888671 g of fine gold, while all other currencies were pegged to a certain amount of gold and, thereby, to the USD. From this par value, countries were allowed to deviate by up to 1 per cent up or down (Proctor 2006: 1337). According to Art. IV:5 of the original Articles, changes to the par of exchange were allowed only in case of “fundamental disequilibrium” – a term not defined on purpose, understood to mean a situation not correctable within the time for which resources of the Fund would be made available to members (Lowenfeld 2008: 623).
 When the IMF issued its last “Schedule of Par Values” on 15 March 1971, 83 of 117 members had established a par value in accordance to their obligations (Gold 1984: 1551). Among the developed members, only Canada – for many years – and Germany and the Netherlands – occasionally – were in breach of their obligations by letting their currencies float (Simmons 2000a: 579).
 The quote, often misattributed to Charles de Gaulle, was coined in the 1960s by d’Estaing who served as France’s finance minister. The criticism found widespread public resonance after Robert Triffin identified the structural unsustainability of the dollar’s role as an international reserve currency, the so-called Triffin Dilemma (Subacchi 2010: 4, footnote 9).
 The most prominent critic of the IMF is Joseph Stiglitz, former chief economist of the World Bank, who accused the Fund of damaging crisis-hit countries through the relentless promotion of the “Washington Consensus” (fiscal discipline, privatization, etc.) (Stiglitz 2002). The IMF’s former chief economist Kenneth Rogoff dismissed Stiglitz’s accusations as “slander” (Rogoff 2002).
 The regard in which the G-7 held the IMF is symbolically demonstrated by the fact that the Managing Director had to leave the meeting of the finance ministers after giving a presentation about the state of the world economy (Lombardi/Woods 2007: 8).
 In total, the Fund has six purposes listed in Art. I: (i) international monetary cooperation; (ii) expansion and balanced growth of international trade; (iii) exchange stability, orderly exchange arrangements and the avoidance of competitive exchange depreciation; (iv) the establishment of a multilateral system of payments; (v) making the general resources of the Fund temporarily available to the members; and (vi) lessen the degree of disequilibrium in the international balances of payments.
 For an explanation of all IMF publications refer to <http://www.imf.org/external/pubs/pubs/per.htm>.
 Note that Art. IV:2 refers to “exchange rate arrangements” (meaning the broad classification or framework of the member’s exchange system) whereas Art. IV:1 speaks of “exchange rate policies” (meaning the specific actions or inactions of members in the operation of their exchange arrangement). Unfortunately, Art. IV is not consistent in the use of its terminology. See the glossary for definitions and Gold 1988: 113.
 A special case is the unilateral peg to another country’s currency. As previously discussed, Michael Mussa claims that the issuing state should have the right to object to this kind of arrangement (Mussa 2007: 8). Charles Proctor argues that, Art. IV:2(b) notwithstanding, international law does not confirm this view. While Art. II:7 of the Charter of the United Nations enjoins states from intervening in the affairs of other states, a peg does not deprive the state intervened against of control over the matter in question. Therefore, a peg constitutes an interference, but not an intervention (Proctor 2005: 567-568).
 Past Art. IV consultations can be accessed online: <http://www.imf.org/external/np/sec/aiv/indexc.htm>.
 Regarded of high importance, the 1977 Decision was tentatively adopted before the Second Amendment on 29 April 1977 by the Executive Directors, subject to an approval at a later stage by the Interim Committee. It experienced some revisions, however only with respect to the procedures for surveillance. For the complete legislative history of the 1977 Decision see section 9.3.2 in the Appendix.
 Louis Pauly recalls the deep divisions that emerged on the design of the code of conduct that would make the amended Art. IV operative (Pauly 2006: 14). Three views came into conflict: the Fund pushed for a broad interpretation to revive the notion of prior consultation before exchange rate changes. Continental European members rejected consultations but called for the Fund to promote policy objectives and to take a view on the correctness of particular exchange rates. The US, Canada and the UK instead deferred to market forces and wanted the Fund to concentrate on the avoidance of manipulation. In the 1977 Decision, this view prevailed.
 This approach differs considerably from the original suggestion for the 1977 Decision by US representatives which foresaw “objective indicators” in the shape of “scattered changes to the level of a member’s monetary reserves”. These indicators would have created an obligation to adjust the balance of payments. However, the idea received little support from other governments (Gold 1984: 1533).
 After 1978 the appropriateness of the 1977 Decision as a basis for surveillance was examined on a biennial basis. These reviews focused mostly on the implementation, rather than on a formal examination (IMF Preliminary Considerations 2006: N. 20). A number of bold reform proposals were not successful. In 1979, for instance, the US suggested that “any nation with exceptionally large payments imbalance – deficit or surplus” was to submit for IMF review how it proposes to deal with the imbalance (IMF Preliminary Considerations 2006: N. 10).
 Since its publication, the 2007 Decision was amended once. A Board decision in 2010 allowed for more flexible consultation scheduling through so-called “lapse of time” procedures: when there is no immediate urgency, the Executive Board discussions of Art. IV consultations can take longer than the regular period of three months (IMF Decision No. 14766 2010).
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- china currency manipulation exchange rate manipulation imf reserve accumulation renminbi current account surplus international law exchange rate surveillance international monetary fund articles of agreement bretton woods