What are the Problems of International Liquidity?


Broadly speaking, the problem of international liquidity has two aspects: quantitative and qualitative. The quantitative aspect of the problem relates to the adequacy of international liquidity. The qualitative aspect of the problem pertains to the nature and composition of international reserves for liquidity.

A major source of worry in maintaining international economic relations is the quantitative aspect of the problem of international reserves. It is generally feared that in future there is likely to arise a shortage of international liquidity.

It is argued that, there is no guarantee that the present international monetary system will automatically provide an increase in the supply of international liquidity over the years to finance the expanding volume of international trade and payments.


As such, the total quantity of international reserves under the present international monetary system is going to be extremely inadequate for the world’s future needs. Briefly, though, there is no shortage of international liquidity at present, it is feared that in future there will be a shortage of international means of payment, under the existing system of international monetary mechanism, which is bound to disrupt trade and international economic relations.

This ‘inadequacy’ fear is the logical outcome of the slow growth of gold reserves in relation to the rate of increase in international trade and transactions and expanding international payments.

The present payments system is essentially a gold exchange standard, requiring a rather high ratio of exchange to gold in official monetary reserves. The gold base on which this payments system is based cannot increase by more than about 2 per cent per annum on an average.

This rate of increase of gold reserves is considerably less than the rate of increase in the volume of international payments. It has been estimated that, the volume of international trade and resulting payments has been expanding at more than double the rate of gold reserve expansion, i.e., about 5.8% per annum. Naturally then it has been observed that there is bound to emerge a liquidity gap, “inadequacy”, creating a serious problem of international liquidity.


Even taking gold and foreign exchange together, the reserves with the monetary authorities of countries who have joined the IMF have been growing at the rate of about 2%-3% per annum, while trade between them has been growing twice as fast. Evidently, the liquidity position of the world has been steadily deteriorating from year to year. Such a belief is commonly shared by all the present international authorities who argue that, if no suitable measures are taken, the entire international monetary system will collapse in future, ruining the world’s prosperity.

In its qualitative aspect, the problem is related to the use of the dollar and sterling as reserve components. The U.S. dollar and the pound sterling are the principal reserve currencies or ‘key currencies’ because of their role as the major trading currencies for carrying out a large number of international trade and investment transactions. However, since World War II, the world’s international payments system has received its main support from the willingness of the world to hold dollars, and use them as international currency. Thus, today, dollar supply plays a pivotal role in determining the total reserves for international liquidity.

In the composition of international liquidity we now find that gold and dollar plus sterling – key currencies – are the major components. But since gold cannot be increased very much, the requirements of growing international reserves may be sought to be met by increasing the supply of key currencies. Now, if key currencies form an increasing part of international reserves, this implies increase in relation to their gold stock of the liquid liabilities of the countries whose currencies are held as reserves by other countries. But should these liquid liabilities grow beyond the reserve-currency countries’ own gold reserves, confidence may be seriously weakened in their continued ability to maintain the par values of their currencies and the stability of the international payments system may be undermined.

This is the precise situation which confronts the U.S. dollar today. As a matter of fact, the United States’ balance of payments deficits on capital account have added to the world’s reserves, but its recent deficits have created a sense of insecurity about the future. Since 1959 the U.S. balance of payments has turned adverse, and she has been losing gold.


This loss of her gold was temporarily halted by the sale of gold by the U.S.S.R., and later by the restoration of confidence through bilateral “swap” credit agreements and standby drawing arrangements with the IMF. However, there is a fear that if the situation is not substantially improved the European countries which have been accumulating dollars only as an act of persuasion, may start any time converting them into gold. If this happens, the U.S.A. might lose large quantities gold, and dollar might have to go off the gold link as the ¬£-Sterling was forced off the gold standard on September 21, 1931. In short, confidence in the dollar is weakening with the decline in America gold holdings.

Thus, there is the international liquidity dilemma. Under the present monetary set up, the increase in the supply of international liquidity, commensurate with increased demand for liquidity due to expanding world trade and transactions, has been dependent on U.S.A.’s willingess to incur continuing deficits in its balance of payments. But persistent deficits in U.S.A.’s balance of payments of the sort that involve accumulation of dollar reserves with the European countries may disincline them to keep their international reserves in the form of dollars.

They may start converting their dollar reserves into gold. This may precipitate a crisis in the Euro-dollar market. This crisis may further reduce United States’ gold holdings, which in turn may generate lack of confidence in the stability of the gold value of the dollar. It may further accelerate a rush for gold.

To avoid this danger the balance of payments deficit of the U.S.A. has to be reduced. And if she reduces this deficit, to that extend world’s liquidity reserves will also be reduced under the present international monetary system! Another repercussion is that when the United States will reduce its grants of loans to newly developing in countries in order to improve her balance of payments, these countries will also have to make undesirable cuts in their development programmes. The problem of bridging the gap in the U.S. balance of payments is thus, interlinked with the problem of international liquidity.


However, the international position of the dollar has not been substantially improved despite the various measures taken by the U.S. Administration. Even the recent devaluation of dollar has not helped much in this matter.

Here it may be pointed out that the real malady of the dollar lies in the continuous imbalance between the United States’ financial and real exports. To the extent that U.S. financial exports are not counterbalanced by its real exports, it has to suffer overall deficits in her balance of payments. Thus, the U.S. balance of payments position can be strengthened only if its real exports are increased.

Moreover, it has also been expressed that the problem of world liquidity cannot be said to have started with the dollar crisis and hence, it cannot be said to have ended with it. It has been pointed out that the supply of dollars as a world currency has not been properly and evenly distributed. If at all therefore, there might have arisen a crisis, it is not essentially for the dollar but for the other non­dollar currencies, especially of the developing countries. As a matter of fact, real crisis may attend the international liquidity position if the present trends in international trade and finance do not change. International liquidity problems arise mainly because each country adopts measures in self- interest.

Thus, the real problem of international liquidity is to remove the existing maldistribution of international reserves and to enable the newly developing countries to pay for the developmental imports. The key to world’s prosperity lies here. The real need for international action is regarding the distribution of capital flow. As the Radcliffe Committee has well observed, it is impossible to disentangle the problems of international liquidity from the problem of international balance (in terms of growing, capital, trade, and transactions).”


The problem of liquidity would not have been so acute had the world trade been having a balanced expansion. But unfortunately, it has been observed that in the recent years the upward trend in payments imbalances was by and large of the same order as the increase in world trade. This means that, if no solution is found to improve the reserve position of the countries of the world, they would in sheer self-protection have to devise measures to prevent a deficit, effecting a breakdown of growing international trade and prosperity.

Thus, it has been widely recognised that something must be done to improve world liquidity. It is obvious that any solution or scheme to improve it internationally must be evolved on the basis of international cooperation.

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