The concept of international liquidity is associated with international payments. These payments arise out of international trade in goods and services and also in connection with capital movements between one country and another. International liquidity refers to the generally accepted official means of settling imbalances in international payments.
In other words, the term ‘international liquidity’ embraces all those assets which are internationally acceptable without loss of value in discharge of debts (on external accounts).
In its simplest form, international liquidity comprises of all reserves that are available to the monetary authorities of different countries for meeting their international disbursement. In short, the term ‘international liquidity’ connotes the world supply of reserves of gold and currencies which are freely usable internationally, such as dollars and sterling, plus facilities for borrowing these. Thus, international liquidity comprises two elements, viz., owned reserves and borrowing facilities.
Under the present international monetary order, among the member countries of the IMF, the chief components of international liquidity structure are taken to be:
1. Gold reserves with the national monetary authorities – central banks and with the IMF.
2. Dollar reserves of countries other than the U.S.A.
3. £-Sterling reserves of countries other than U.K.
It should be noted that items (2) and (3) are regarded as ‘key currencies’ of the world and their reserves held by member countries constitute the respective liabilities of the U.S. and U.K. More recently Swiss francs and German marks also have been regarded as ‘key currencies.
4. IMF tranche position which represents the ‘drawing potential’ of the IMF members; and
5. Credit arrangements (bilateral and multilateral credit) between countries such as ‘swap agreements’ and the ‘Ten’ of the Paris Club.
Of all these components, however gold and key currencies like dollar today entail greater significance in determining the international liquidity of the world.
However, it is difficult to measure international liquidity and assess its adequacy. This depends on gold and the foreign exchange holdings of a country, and also on the country’s ability to borrow from other countries and from international organisations. Thus, it is not easy to determine the adequacy of international liquidity whose composition is heterogeneous.
Moreover, there is no exact relationship between the volume of international transactions and the amount of necessary reserves In fact, foreign exchange reserves (international liquidity) are necessary to finance imbalances between international receipts and payments. International liquidity is needed to service the regular How of payments among countries, to finance the shortfall when any particular country’s out payments temporarily exceed its in-payments, and to meet large withdrawals caused by outflows of capital.
Thus, external or internal liquidity serves the same purpose as domestic liquidity, viz., to provide a medium of exchange and a store of value. And the primary function of external liquidity is to meet short-term fluctuations in the balance of payments.