A month before the start of the Tokyo summit, Treasury Secretary James A. Baker III and his deputy, Richard Darman, quietly began work on a plan to revamp the international monetary system -- a plan that was kept so secret that few others in government, including some Treasury officials, knew they were working on it.
After getting a go-ahead from the president, chief of staff Donald T. Regan and Secretary of State George P. Shultz, Baker broke out the idea first for the British during the Interim Committee meetings of the International Monetary Fund.
Then, in secret bilateral sessions in Paris at the time of the April 17 Organization of Economic Cooperation and Development meeting, he lined up approval from the French and Japanese authorities.
The latest Baker Plan is designed to bring about a compromise between the old system of fixed exchange rates that expired in 1972, and the present system of floating rates, which has resulted in much too much volatility in currency values.
When added to the first Baker initiative last year at the Plaza Hotel for a coordinated intervention to bring down the over-valued dollar, and his second scheme -- to find a solution to the Third World debt problem -- the new step underscores a dramatic shift by the Reagan administration from ideological nonintervention in markets to the "pragmatic" policy Baker has followed for the past 18 months.
And its approval at Tokyo was seen as a coup for the United States -- the only one on the economic front, inasmuch as the American team did not get what it wanted in terms of a starting date for a new trade round, or the inclusion of agriculture in the round. And it failed to get a commitment from Japan and West Germany to boost their domestic economies.
But the initiative on monetary reform could have major long-term implications. "What we now will have is a managed float," said one official, meaning exchange rates that are flexible, but only up to a point. The mechanism governing the managed float is a series of regular meetings at which the seven major nations will take "remedial measures where there are significant deviations from an intended course."
Nonetheless, officials stress that no nation will give up any measure of sovereignty under the contemplated new monetary system. "Any nation that does not want to play the game doesn't have to," said a key American official.
But in practical terms, now that the seven major nations of the non-Communist world have committed themselves to this self-imposed "surveillance" procedure, it will be hard for one to buck the wishes of the others.
At regular meetings -- either in groups of five or seven -- they will measure each others' individual economic forecasts, taking into account these indicators: economic growth rates, inflation rates, interest rates, unemployment rates, fiscal deficit ratios, current account and trade balances, monetary growth rates, reserves and exchange rates.
That list was specified in the communique itself -- amounting to a precise instruction from heads of government to their finance ministers to make a detailed comparison of what is going on in their economies, while making sure that there is a logical relationship among those indicators.
Baker informed Federal Reserve Board Chairman Paul A. Volcker of the plan before going to Tokyo, and won his general approval.
The West Germans, expected to be, as they were, the least enthusiastic, were approached last among the Group of 5 nations (Japan, West Germany, France, and Britain in addition to the United States), and only when Baker could indicate he had support of the others.
The final details were not hammered out until the first day of the summit in Tokyo, when Baker made language concessions to the Germans that made them more comfortable with the final product. For example, the word "objective" was removed from the reference to "indicators," because the Germans feel that "objective indicators" imply too much of a commitment to automatic behavior.
Whether Baker can achieve his goal of melding the best of the fixed and flexible exchange rate worlds remains to be seen. It will take, at a minimum, an extraordinary degree of cooperation among the major currency nations that comprise the Group of 5.
Under the compromise negotiated in Tokyo, the Group of 5 will be joined from time to time by the finance ministers and central bankers of Canada and Italy, making a brand new Group of 7.
"If one of the nations doesn't want to go along with the call for a meeting -- and any of the Group of 5 can issue a call for a meeting -- the others, if they felt strongly about it, would probably go ahead. And I doubt that anyone would want to be left out," an official explained.
"There could well be, and should be, a certain amount of peer pressure and public pressure for corrective action when a country's performance gets way out of line," he said.
The system that Baker evolved comes close to, but not quite, the "target zone" approach that is favored by the French government, as well as by some bankers and academicians in this country.
Under target zones, the countries involved would set an allowable range for their currencies to fluctuate. If the currencies then appeared ready to break out of the agreed-upon zone, they would be obliged to take immediate action -- especially exchange-rate intervention -- to prevent that from happening.
The Tokyo agreement does not specify targets for exchange rates. But it does call for each of the five countries, and sometimes for the seven, to explain to each other why their exchange rates are deviating from their own forecasts.
In contrast to a more rigid target-zone procedure, the new system cannot force them to take corrective action. But Baker's expectation is that the reality of the great interdependence of economic activity will in fact work to push any major nation that gets out of line to get back in, first by changing its basic policies. Intervention could be one such step, but not necessarily the first.
"The main sanction here will be political will, we're improving the political system," said one official. "Presumably, all of these discussions among the G-5 or G-7 will be confidential. But if one nation holds out against the other four, or the other six, as the case may be, you can be sure the word will leak out."
Some outsiders remain skeptical. "Will they really blow the whistle on each other?" asked C. Fred Bergsten, director of the Institute for International Economics.
Bergsten, who advocates outright target zones, fears that the new system may suffer, as does the General Agreement on Trade and Tariffs: The GATT operates under a series of well-intentioned principles, he points out. But the participating nations honor them more in the breach than in the performance.
A senior administration official responds that even if the new plan doesn't work fully up to expectations, it is bound to engender more international economic policy coordination than has ever been the case before.
And in part, Baker is known to feel, this can be attributed to the great success of the Plaza Hotel agreement of Sept. 22, when the G-5 made its historic agreement to force a devaluation of the dollar. Analysts may argue that the G-5 struck at precisely the optimum moment in history, when the dollar had already started down.
Nonetheless, the Plaza agreement worked, and demonstrated two things: a willingness of the United States to reassert its leadership of the international economy; and the ability of the major nations to work in harmony for international objectives, even when they might be considered somewhat contrary to narrow domestic objectives. Thus, Japan agreed to begin boosting the value of the yen, even though that would prove costly to some of its exporters. Right now, with the yen at a modern post-war high, the Nakasone government is coming under political assault from opposition parties that suggest that Prime Minister Yasuhiro Nakasone gave away too much at the Plaza. Baker argued at the Tokyo summit that the major nations needed to go beyond the Plaza agreement, and make the informal procedures they had agreed to more regularized and formal.
"The floating rate system which has been in place since the early 1970s had a number of positive elements, but it contained too much flexibility and too little commitment to coordinate economic policies," a senior administration official said.
The essence of the plan is that each of the nations agrees that after its set of economic indicators and forecasts is examined, they will make the changes necessary to bring them back into line if the others conclude that there have been significant deviations. Or, the nations might agree that the time had arrived for joint intervention to change the value of their currencies.
This multilateral "surveillance" excercise will be undertaken with the assistance of IMF Managing Director Jacques deLarosiere. But American officials make clear that deLarosiere's is a "fact-finding" role, not a policy role: The decision that one of the major countries is out of line and must make changes is up to the G-5, or the G-7, as the case may be.
"DeLarosiere will come in and put the technical facts on the table," said a senior administration official. "Then there is a discussion, and he expresses opinions about the need for, let's say, the United States to be more aggressive in reducing its fiscal deficit, or the need for Japan to open up its markets and that sort of thing." But the decision on what action should be taken -- in the above illustration -- by the United States or Japan would be up to the other nations, not to deLarosiere.
Nonetheless, IMF officials welcome the Baker plan as a significant step that will test the outer limits of international cooperation. They are gratified that by bringing deLarosiere into the process, the IMF moves into the power structure's inner circle. And, in practice, they expect that deLarosiere's function will go beyond mere fact-finding.
The creation of the G-7, without the abolition of the G-5, was a political compromise. Some members of the G-5, especially Britain and West Germany, refused to let Italy and Canada join the G-5 on a full-time basis, fearing dilution of the power of their group. However, the Italians and Canadians not only made a persuasive case that the G-5 decisions on exchange and interest rates had an overwhelming impact on their economies; they indicated they would frustrate summit approval of the Baker initiative for greater overall policy coordination if their demands were ignored.
The compromise was to create the G-7, which will meet at least one a year, and at other times when the G-5 decides to take up an issue affecting Canada and Italy.
Only time will tell exactly how the system works. There is no set date for the first G-5 meeting under the new system, or for the first G-7 session, although one of each is likely before the fall annual meetings of the IMF and World Bank in Washington. Before those meetings there is likely to be a meeting of the deputies of each, to set out an agenda. There also might be an organizational meeting ahead of those first operational meetings.
A high official indicated that when the G-5 decide to have a meeting from which Canada and Italy are excluded, they will be informed privately "so they don't read about it in the paper." One technical reason for the differentiation is that the currencies of the Group of 5 are the ones on which the IMF's Special Drawing Rights, the IMF international credit, are based. The presumption is that those countries therefore have a special responsibility in the international monetary system.
But the real reason is political: If the G-5 were abandoned, and all decisions were made by a G-7, a source said, there soon would be pressure to scrap the G-7, and put all decision-making into an even more cumbersome G-10. Thus, the intention is that the G-5 remain the key agency.