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Transcript
Special Drawing Rights: An Explanation of their Current Role
and Future Function
Cora Pettipas and Halia M. Valladares Montemayor
The objective of this paper is to analyze alternatives to global
currencies; as well as, the potential new currency based on the
International Monetary Fund’s Special Drawing Rights (SDRs). The
nature of SDRs is then described and the potential future use of
them as a currency to stabilized currency risk in global trade.
Countries then retain their own currencies and set their own
monetary policies. The SDR allocations could be based on current
account and balance of trade surpluses and could be called a
current account SDR system to make the SDR a true store of
value, and relatively stable.
Introduction
The world economies have become globalized. All our economies are highly
interconnected, creating a need for a sound global international monetary system to
facilitate global commerce. With the pressures multinational companies, as well as
trading blocs, markets have become more integrated. Expansion of markets from the
development of regional trade agreements such as NAFTA, and the European Union
has decreased tariff and non tariff barriers to trade. A further reduction of physical
barriers has been assisted by the digital age and explosion of technology in all aspects
of international business such as international outsourcing of services, to procurement
and supply chain management. The emergence of the global economy has increased
trade between countries. This trend is greatly necessitating the emergence of global
governance agencies and mechanisms.
This explosion of global trade and commerce has put pressure on the monetary system
that still is exhibiting strain. There is an increase in cross border financing by
multinational corporations seeking the most favorable financing rates. There is also
increased interdependence of the financial markets, with increases in partnerships
between exchanges of different countries aiding in debt and equity financing for
multinational companies. In addition, companies are now structuring themselves as
transnational, with subsidiaries in various countries and markets. There is also an
increase in joint ventures and business partnerships of companies across borders
(Griffin, 2006). All of these emerging international business trends have been placing
increasing strain on the home countries balance of payments and current accounts
coordination.
The current account for each country is an indication of the flow of value and trade.
Some countries have a trade surplus meaning that the net capital outflows from that
___________________________
Cora Pettipas, CFP, FCSI, Ph.D. Candidate, Swiss Management Center University
Halia M. Valladares Montemayor, Ph.D. Associate Professor, Mount Royal University
country are greater than the inflows. Other countries are considered to have a trade
deficit where the opposite happens, the countries net imports are greater than the net
exports. Traditionally, it was accepted that trade surpluses were good and trade deficits
were bad for the home country in terms of prosperity and job creation. However, as we
continue to globalize and integrate our economies, it is becoming clearer that either a
surplus or deficit is negative, as if one country has a surplus; another has to have a
corresponding deficit (Cohen, 2008). After the Asian currency crisis, the Asian countries
scrambled to eliminate their current account deficits. The result of this was the United
States becoming the ‗deficit of last resort‘ because they can afford to take on large
trading deficits as their currency is still the most popular global currency reserve asset
(Stiglitz,2009).
China took the lead in what has been termed a ‗savings glut‘ by Asian countries
contributing to the global monetary imbalance. In doing so, they built their currency
reserves in US dollars. It is estimated that China currently holds two trillion USD in their
reserves (Anklesaria Aiyar, 2009). The U.S. can absorb the current account deficits as
they happen to produce the currency that is the most popular for global trade and
reserves. The IMF estimates that 64% of all foreign reserves are USD denominated
(Humpage, 2009). In addition, the USD is still the billing currency of 45% of international
transactions. However, now that the USD does not have a fixed value, coupled with
consistent U.S. deficits and multiple quantitative easing measures, there are concerns
that the dollar will continue to lose its value (Bergsten, 2007). These concerns are
advocated by the BRIC nations, especially China as they are overexposed and need
diversification away from the currency risk of deflation of the U.S. dollar (Anklesaria
Aiyar, 2009; Xiang, 2010).
The objective of this paper is to analyze alternatives to global currencies; as well as, the
potential new currency based on the International Monetary Fund‘s Special Drawing
Rights. The nature of SDRs is then described and the potential future use of them as a
currency to stabilized currency risk in global trade. This is an exploratory and
descriptive research based on secondary data from reliable sources source as World
Economics, Journal of international Affairs, Journal of Financial Management & Analysis
to name a few.
THE IMPORTANCE
BUSINESS
OF A
GLOBAL
CURRENCY
IN MEASURING INTERNATIONAL
Multinational companies go to great lengths to neutralize the currency risks brought
about by international commerce and trade. Most currencies are allowed to float with
market forces. The currency price is determined by supply and demand market forces.
In addition, sovereign nations can manipulate the supply of their currencies using
monetary policies to protect the economic interests of their country (Bergsten, 2007).
Companies have translation and transaction risks as a result of doing business in
multiple currencies (Griffen, 2006). Multinational companies that already operate on thin
margins can have a quarter‘s profit washed away by even a small change in value of
un-hedged currency transactions.
There are a few terms that are important for the understanding international trade. The
balances of payments for a country are a summation of all the capital inflow and
outflows from goods, services and capital. This is used to measure the trade balance of
a country, which captures if a country is a net importer or exporter of goods. A net
importer consumes more goods than it produces, and net exporter produces more
goods than it consumes. Alternatively, a current account is a broader measure of the
import and exporting activity of a country as it includes trade of goods, services,
royalties, patents, employee remuneration, travel and tourism, gifts and grants. The
current account is a more accurate and holistic account of a nation‘s economic balance
(Butler, 2010).
To add to the complexity of measuring international trade and business activities, each
country has its own measure of economic value, or currency. Traditionally, the
international monetary system went from a fixed exchange rate system where the
values of hard currencies were fixed to a relatively nonexpendable resource like gold (or
silver). After the fall of the gold standard, major national currencies were un-pegged to a
fixed commodity of precious metal and were allowed to float with free market forces
(Thakur, 1994). This will be discussed more in later sections. These new currencies are
called fiat currencies, as they are not backed by any fixed commodity or resource, just
the general ability for sovereigns to extract taxation from their populace (Butler, 2008).
A fixed, nonvolatile currency value is very important for international business (Thakur,
1994). When a company prices and invoices in one currency, it can stabilize its
accounts payable and accounts receivable in a predictable manor, knowing the
business profitability of operations as long as sales projections are accurate. When a
company does business in multiple countries and multiple currencies, each with a
precarious floating value, predicting profitability of operations becomes much more
challenging (Griffin, 2006). The company either has to incur the expense of hedging or
they have to accept the volatilities of international inflows and outflows. This is why
accounting, pricing and invoicing in one currency is ideal (although not always practical)
to eliminate currency risk. The next section will explore potential one currency models.
Contenders for the Global Currency Status
THE STATUS QOU: THE AMERICAN DOLLAR
The U.S. dollar has been the dominate currency in global trade since 1944, replacing
the pound sterling. The U.S. dollar was pegged to gold until 1971, when 42 USD could
be converted into an ounce of gold. The U.S. treasury was not able to meet this
conversion obligations and therefore un-pegged their currency from gold. Since then
their currency, as with most global currency, has been able to float with market forces of
supply and demand with no constraining limit on the production of the USD (Byrne,
1982). Currently, The United States is in poor financial health, increasing the volatility
and risk associated with holding the dollar as a reserve currency, or using it for
international transactions (Rowley, 2011). The U.S. had debt to GDP ratio of 40.8% in
2008, with a projected debt to GDP ratio of 70% in 2009 as they continue to operate in a
deficit. As the United States continues to monetize their debt, global fears of inflationary
pressures will devalue the USD (Stiglitz, 2009). Other reports suggest that at the current
level of taxation (income) and expenditures (spending) the U.S. debt to GDP ratio is
projected to reach 100% in 2023, and 200% by 2038 (Burman, 2010). This large of a
debt to GDP ratio happened once before in the U.S. during the second world war, but
this is expected to happen in times of crisis, as opposed to the current debt being
created from entitlement spending (Amaral, 2010). If a household managed their
money like this, they would be in default and progressing towards bankruptcy. The U.S.
budget deficit in 2009 was 9% of GDP, which is 3 times the European Union limit of 3%
for European countries (Welch, 2010).
The second major concern in continuing to use the USD for the global currency
reserves is the fears that the U.S. government will not fight inflationary pressures, as
that would decrease the real value of debt obligation they now hold. This would not be
without a cost for the U.S., as foreign creditors would demand higher interest rates from
the U.S. Moody‘s Investor Service has contemplated a downgrade of U.S. Treasury
bonds, which would drive yield demands higher. This is a complicated situation both for
the U.S. and for its debt holders as the U.S.‘s major debt holders (excluding intragovernment debt)are also its major importers, like China, Japan, Oil Exporters, and
Russia (Burnam, 2010). These major debt holders are also depending on U.S.
consumption to maintain their own economies and would ideally like to maintain their
exports to the U.S. at previous levels. One strategy China and Japan are undergoing is
buying inflation protected US denominated assets as an alternative to traditional
Treasury Bills, which will protect against inflationary pressures. This product does
protect against inflation, but not exchange rate risk (Stiglitz, 2009).
The third major concern of having the dollar as the international global key currency is
exchange risk (Bergsten, 2007; Rowley, 2011). With the USD having a dual role as a
key currency as well as a sovereign currency, it has a conflict between global interests
and sovereign economic interests. The U.S. is the largest net debtor in the world
(Alessandrini, 2009). A systematic devaluation of the dollar (as other countries have
done) would make US exports more competitive imports less so. Also, it would facilitate
foreign direct investment into the U.S. creating job growth and counteracting the
deindustrialization that the strong dollar has had on the U.S. This could facilitate an
economy based on production and savings as opposed to consumption and leverage,
hopefully returning the U.S. economy to balance (Ussher, 2009). This would be great for
domestic policy, but a devaluation of the dollar would also reduce the value of the USD
denominated global reserves, destroying the value those countries reserves and their
hard earned savings.
One currency cannot act as both a sovereign currency as well as have the ―exorbitant
privilege‖ of producing the global currency, as there are inherent conflicts built into this
system (Alessandrini, 2009, pp 52). With the increase in global commerce paired with
the de-pegging of the U.S. dollar to the gold standard, there needs to be a new currency
that can be used for reserve funds to help support balance of payments and current
accounts around the world. As Joseph Stiglitz (2009) as theorized, the system in place
creates a reverse foreign aid, where developed countries who should be saving and
lending are borrowing and developing countries who should be borrowing and spending
are lending at low U.S. treasury rates. A global currency is also needed to price fix for
commerce to decrease risk of currency exposure and to simplify trade. Due to the
factors discussed, the US dollar as the key currency is no longer desirable for global
markets (Bergsten, 2007; Rowley, 2011).
THE NEW CONTENDER: THE EURO
The most prominent alternative for a reserve currency is the Euro, which is now the
second largest trading currency in the world (Cohen, 2008; Cooper, 2010). It is the
standard currency of 17 countries in the European Union (EU). It started as an
accounting quasi currency in 1979 called the European Currency Unit (ECU) (Thakur,
1994). The ECU was valued as a basket prorated based on 11 participating European
countries currencies. It was replaced by the Euro on a 1:1 conversion basis in 1999,
and then entered circulation as a full currency in 2002. For business operating in
Europe, the Euro eliminates currency risk as it can produce and sell products and
services in the same currency unit. There has been a criticism of the Euro, as the
participating country‘s monetary systems are now linked through the European Central
Banks (Cohan & Subacchi, 2008). Each country in the European Union has conceded
autonomy and has to operate their financial affairs within the constraints of the rules of
the European Union (Cohen, 2008; Wilde, 2009).
The Euro is still in its infancy. There were initially high hopes that the Euro would fast
replace the U.S. dollar as the world reserve currency (Cohen, 2008). However, it
devalued just after being launched and there are still concerns about its future. In
Europe, the Euro has surpassed the dollar as the most common invoice currency. It is
also the second most traded currency on foreign exchange markets at this time, at 20%
of the daily transactions. The USD is still prominent at a 45% share. However, the Euro
has advanced the USD in international bond issues. There is also demand from central
banks, especially in Asia; to diversify their reserve holdings out of USD into Euros as it
they are now seen as a better store of value than the USD (Alessandrini, 2009).
Even though the Euro is a strong international currency, it is doubtful it would make the
best official reserve currency. Even if it did, it would be plagued with the same innate
conflicts as the USD in terms of having a dual purpose: being a local (continental)
currency as well as a global one. The Euro would have to satisfy two competing and
sometimes contradictory purposes of being a stable reserve currency and enhancing
property of Europe. Although the currency lacks the power and influence the pound
sterling once enjoyed, the Euro appears to have a strong future and the strength of
Europe united seems to be more forceful than the individual countries like Germany and
France. United, it rivals the U.S. in terms of GDP, production, population and trading
volume (Cohen & Subacci, 2008). .
OTHER CURRENCY OPTIONS
Since the gold standard broke down, there are three basic alternative discussed in
currency literatures: a well used fiat national currency, a commodity based currency, or
a global fiat currency. The Gold standard is the last popular currency based on a
precious metal, a form of commodity currency. The gold standard fell in 1972 when
countries turned to fiat or floating currencies. Gold was an ideal asset to use as
currency at the time, as it was malleable and limited in quantity. Although some
economists call for the return of the gold standard, it is unlikely (Wessel, 2010). It
collapsed mainly because the supply could not keep up with burgeoning trade. In
addition, the central banks of the world did not always abide by the rules of the gold
standard. Distribution of paper notes within the limits of the gold reserves, and other
fraudulent practices (Ussher, 2009). William‘s key currency proposal was popularized at
the Bretton Woods conference in 1944 as an alternative to the gold standard called for
one key currency or a basket of currencies as the best alternative. At the same time,
Keynes called for a convention called the Bancor which was an accounting currency
that would work as a clearing house for countries to facilitate trade. The Special
Drawing Rights (SDRs), a creation of the International monetary fund has
characteristics of both, and will be discussed further in this paper.
Other than the most used national fiat currencies, an interesting, albeit unpractical,
alternative for the global reserve currency has been put forward: a commodity based
currency. A currency based on an underlying basket of commodities was an idea
brought forward by Nicolas Kalder as a way to make the international currency system
more fair and disciplined. This could be built on John William‘s idea of a ―key currency‖
and John Keynes‘ idea of the proposed Bancor. The commodity based currency
proposed that each unit of currency be backed by a physical basket of commodities
warehoused solely for this purpose. Selected commodities would be stored including
raw materials, edible oils and precious metals to back the value of the currency note.
There would be copious rules and regulations about which commodities would be
included, inventory management and turnover. Therefore, the note, or currency would
literally have a store of value backed by these commodities (Ussher, 2009). As currency
is the medium of exchange so that one can distribute the timing of production of a good
or service with the consumption of it, this alternative is more of an intellectual idea than
a pragmatic one (Thakur, 1994). However, the idea of a currency being backed by
something of tangible value as opposed to Fait currency is an appealing one. As central
banks print fiat money that is solely based on the future tax revenue of the populace is
precarious as it sets no realistic and controllable limits on the money supply, leading to
possible devaluation and inflation.
Special Drawing Rights
THE BACKGROUND OF SDRS
An alternative global reserve currency, or key currency, could be developed from
Special Drawing Rights (SDRs) which are now used as an accounting currency by the
International Monetary Fund (IMF). The IMF is a global governance organization that
also came out of the Bretton Woods Agreement. It is widely debated what a Special
Drawing Right is, which is really a debate of what we determine as money or a means
of exchange. The IMF was developed to oversee the international monetary policy as
there were fears that countries would go back to protectionist economic policies that
were not conducive to trade and thus could lead to another great depression (Griffin,
1982). To prevent this, SDRs were created to help implement the IMF‘s objectives to
facilitate trade by making resources temporary available and to correct the balance of
payments. Each member country paid a quota in gold to contribute to the IMFs initial
reserves. The size of the quota was determined by the countries influence in the IMF
through voting rights as well as determined the countries borrowing power from the IMF
denoted as Special Drawing Rights (Cohen, 2008). After the un-pegging of the U.S.
dollar to the gold standard, the IMF decreased in relative importance as the floating rate
exchange system for fiat currencies was established, and the fear that the world would
run out of USD was unfounded and also eroded the need for foreign exchange reserves
(Anklesaria Aiyar, 2009). It was not until the global economic crisis in 2008 that the IMF
gained attention as a potential solution to the global financial crisis, particularly the
liquidity predicament. The G-20 summit in April 2009 restored the IMF to global
prominence. A general allocation of 250 billion new SDRs were issued by the IMF as a
short-term solution (Griesgraber, 2009).
Special Drawing rights are not intuitive to understand. Initially, they were pegged to a
fixed amount of gold equal to one USD (Humpage, 2009).SDRs have been classified as
a unit of account, a derivative, a debt, an asset, or a quasi currency Special drawing
rights were created by the IMF in 1969 as a potential reserve currency to increase
liquidity and facilitate a new global currency (Hood, 1983; Wessel, 2010). There are
currently 308 billion SDRs in existence (IMF External Relations Department, 2010). This
makes up about 4% of the world reserves (Thao, 2009). At the time, the world had two
global supply reserves, gold and the U.S. dollar (Byrne, 1982). The amount of gold was
strained under the amount of global trade and funds needed. SDRs were meant to be a
solution to the expected global shortage of US dollars and gold.
Special Drawing rights are also a Unit of account, as opposed to a currency. SDRs
represent a claim on the IMF‘s reserve assets and are the official unit of account (Byrne,
1982). The IMF‘s SDR general allocations are by approved by the Board of Governors.
The latest and largest general allocation of SDRs by the IMF was in 2009, of 250 billion.
General SDR allocations simultaneously increase a country‘s share of SDR holdings
and allocations. The holdings are considered an asset, and the allocations are a
corresponding liability. The latest allocation was in response to the 2008 global financial
crisis. This new allocation was to create liquidity in the global market system. It has
been a criticism by advocates of developing nations that 170 billion of the 250 billion
were allocated to richer countries because it is based on quota. Sub-Saharan Africa, for
example, received 11 billion SDRs (Jellema, 2010).The United States got the largest
SDR allocation, as they have by no coincidence the largest voting power at the IMF,
almost 17%. Having SDRs credit to the accounts of each country increases the
resources that country has to draw on, and decreases the need to hold mass amounts
of reserve currencies for global trade and currency fluctuations.
Special Drawing Rights are argued to be a derivative, meaning that its value is derived
from other currencies. This is similar to the European Currency Unit (ECU) was before it
was replaced by the Euro in 1999 (Hood, 1983). The ECU was an accounting currency
based value of underlying European currencies of 12 participating countries at the time
(Allen, 1993). SDRs are valued based on a basket of four global currencies: The U.S.
dollar (44%), the Euro (31%), the Japanese yen (11%) and the British Pound (11%)
(Bergsten, 2007; The Pak Banker, 2011). This means that 1 SDR can be converted into
these for currencies in their respective proportions (Alessandrini, 2009). The value is
based on a five currency basket (the Euro used to be the Deutschmark and the French
Franc) that is readjusted every five years (Ekpenyong, 2007). The IMF decided to only
use the top four hard currencies as these are currently the most important currencies in
international trade and payments (Daniels, 2011). They are seen as more stable and
less volatile to price fluctuations. Also, it creates simplicity to the unit value that can be
easily transferred to its underlying currencies as the major concern for the finance
sector is liquidity. Using all the 120 participating IMF countries currencies would be
more accurate pricing, but would increase the complexity of the SDR and decrease the
liquidity. As the second largest economy in the world, the Chinese Renminbi is
noticeably missing from this basket, as presently it is not considered an international
currency (Cheung, 2010; Xiang, 2010; IMF Strategy, Policy and Review Department,
2011).
THE SDR AS A CONVERTIBLE INTEREST BEARING NOTE
Special Drawing Rights can also be considered a convertible interest charging short
term line of credit. If the country‘s SDR allocations exceed their SDR holdings with the
IMF, then they are charged interest on the difference. Nations can convert part or all of
their SDR allowable allocations to the underlying basket of currencies (or market
equivalent of one currency) for use in their economy as an alternative to holding or
drawing upon their official reserves. For example, if a country can withdraw 1 billion
SDRs from its allowable allocations over and above its SDR holdings from their account
with the IMF. The SDRs are converted to American dollars at the current rate of 1 USD
= 0.628219 SDRs (IMF External Relations Department, 2011). The exchange rate is
based on the current market rates of the 4 underlying currencies. This means that the
country will receive 1.563 billion dollars in U.S. currency to settle its current accounts or
provide liquidity to its economy. The country will then pay back the funds borrowed
which will be converted back to SDRs at the IMF. While the country‘s SDR‘s were
cashed in, they are paying a current interest rate of 0.39%.If the country used the SDRs
for 182 days, then their interest cost (based on current rates) would be $3,048,366
million USD or 1,950,000 SDRs. The interest rate is a prorated rate based on short
term debt instruments in proportion of the underlying currency basket.
Alternative to the above example, Special Drawing rights can be a short term interest
bearing note, an asset for countries whose SDR holdings exceed its SDR allocations.
When this happens, the country receives a rate of interest in SDRs equivalent to the
short term lending rate discussed above, (IMF External Relations Department, 2010).
The lack of spread on the SDR lending and investing motivates drawing SDRs and
penalizes saving them. With a cumulative general allocation of 8 billion dollars, for
example, the SDR holdings would be 8 billion and the SDR allocations would be the
same amount, so there is zero net effect on cash flow. Instead of building up a country‘s
reserves to handle balance of payments and other short term liabilities, it can access its
SDR allocations, similar to a checking account at a bank with a very low rate of interest.
The allocation limit would be the overdraft amount, the holdings and allocations would
initially net to zero. If you overdraw your account, you are charged a current rate of
.39% interest, and if you have a surplus in that account then you get paid .39% on the
account. In practice, the amount owed or earned would depend on the timing of the
balance of payments going in and out of the account, ideally netting to zero.
Lastly, SDRs can also been seen as a quasi currency. It has also been argued that
price; as opposed to currency is what is important in international contracts. Although
not a hard currency, some countries and multinational companies have taken the
initiative to price their products and services in terms of SDRs. The legislated Rotterdam
rules (2009) limit the liability of carriers‘ product value in terms of SDRs as opposed to
any one national currency. The Hague-Visby and Hamburg Rules use SDRs to measure
package limits, as does the Montreal convention for over limit baggage on international
aircraft carriers (Marling, 2010).
The Future of Special Drawing Rights
There are some substantial barriers to the SDR becoming a reserve currency. The
major barrier is the United States, who has almost 17% voting share of the IMF. Any
major policy to be approved takes 85% majority, to the U.S. essentially has veto power
as long as it wished to block the SDR as a reserve currency to try and preserve the
dollars status (Bird, 2010). Second, it has been argued that the SDR cannot become a
currency, as the IMF does not have the ability to tax its populace (Anklesaria Aiyar,
2009). It is true that the IMF does not have the direct ability to create revenue through
taxation. However, the members of the IMF, the countries themselves, do have that
power. So the IMF does have the indirect ability to create revenue through taxation, just
like the fiat currencies of the Euro and the dollar. Not to suggest that the global
populace have another tax levied unto them, but that the taxation powers are there
indirectly through IMF ownership. Thirdly, as with Mayard Keynes idea of the Bancor,
countries still admonish the idea of giving of independent monetary policies through use
of their printing press. (Anklesaria Aiyar, 2009). This monetary policies influence foreign
exchange markets as well as intervene in business cycles for the purpose of increasing
prosperity for the country‘s populace. Oddly, the main supporter of the increased role of
the SDR is China, as well as the rest of the BRIC nations (Kenen, 2010). This is
curious, considering the next emerging fiat currency would most likely be the Chinese
Yuan, although it is not considered an international currency at this time (Griesgraber,
2009; Cheung, 2010). The idea of an IMF substitution account, or open ended SDR
denominated fund, is being promoted by China‘s governor Zhou Xiachaun. China‘s
support has been criticized as being self-serving (Bird, 2010). Zhou also states that he
would like a global currency that is, “disconnected from economic conditions and
Sovereign interests of any single country” (Humpage, 2009, pp 1). Zhou believes that
the current system has lead to the imbalances and the current financial crisis, mirroring
what was said by Keynes in 1944. China would like to diversify its reserve assets from
the USD, to the SDR, which is only 44% USD. The criticism with this account is that it
would transfer the USD currency risk from China to the IMF.
One of the major drawbacks to SDRs currently is the lack of understanding of their
nature. SDRs lack simplicity. Are they money, or are they credit? When people look at
any fiat currency, the same could be argued. Money is an agreed upon medium to
transact goods and services. Currency is like a battery, it stores value from the
transference of one type of energy to the other. When a worker receives their paycheck,
it is stored as a monetary amount until it is transferred, or exchanged into food, shelter,
and gas, etc. Simplistically, if the employer paid the worker for his services in shelter,
food and gas then there would be no need for money. This money is stored value
readily transferred into other energy once used in a transaction. Being seen in this
example, money is an asset to the worker and a debt from the company. Currency in
and of itself is not an asset or liability as it does not generate wealth or take from it
unless transacted. Money stores value, and is a unit of account readily acceptable by
markets. As an accounting currency for the IMF, it does have a unit of measure.
THE VISION OF THE INTERNATIONAL MONETARY FUND
The IMF has long term reforms in mind for the SDR, subject to approval of the IMF as
well as changes to its articles of amendment. They see the SDR in the embryonic
stages of a global currency that could be used as the main reserve currency. To do this,
SDRs needs to have as a unit of account, a store of value and a means of payment, as
that is the true measure of a valid and workable currency. At this current time, it is a unit
of account and has a limited store of value (Cooper, 2010). “In the longer run, if there is
political willingness to do so, these securities could constitute the embryo of a global
currency. Of course, this longer term vision is highly hypothetical and support for the
nearer term steps does not imply commitment to the longer term ones.” (IMF External
Relations Department, 2010, pp 12) Some of the main proposals include the private
use of the SDR, development of an SDR substitution account, and development of SDR
securities.
The private use of the SDR would be an interesting advancement in SDRs. At this time,
there are no private market holdings of SDRs (The Pak Banker, 2011). They are an
accounting currency with the IMF. As the paper discussed earlier, international laws and
corporations have started pricing transactions in SDRs, but pricing is not the same as
invoicing. The advantages of multinational corporations pricing transactions in SDRs, is
it reduces the risk of using a single currency. When a single currency is used with
companies that operate in multiple currencies, then there is always a risk of windfall
earnings of deficits dues to fiat currency rate fluctuations. Even if these transactions are
perfectly hedged, corporations face translation and accounting exposure. In addition,
historical information on pricing and costs would be more accurate and easy to extract if
one single unified currency was used. If the private sector could hold SDR notes than it
would add to their ability to invoice in SDRs as well as use them as a source of liquidity.
This strategy would need consent from key central banks, and could mimic what the
current SDR reserves do for countries and for the private sector (IMF External Relations
Department, 2010).
A second expansion that is planned by the IMF is the expansion of SDR securities in
the form of SDR denominated bonds. This would be an expansion on the SDR
denominated short term notes that were issued in 2009 (The Pak Banker, 2011). The
IMF states that this would serve two important functions. First, they would add to the
supply of alternative reserve assets for central banks. Second, they could serve as a
way of benchmarking for private institutions offering SDR denominated securities.
These bonds, issued by private institutions, could also be utilized to meet the financing
needs of multinational corporations. There was considerable research on if there was a
market for this form of bond by the IMF. Simplistically put, they found there was a
demand for this form of bond, but the main concern the private sector had was liquidity
of the bonds. The main solution discussed was the addition of a liquidity premium of 50100 basis points, similar to what the ECU banking Association did for ECU denominated
debt from 1979 to 1999.
The third aspect of the evolution of the SDR would include the substitution account. This
concept has gotten a lot of attention as it is advocated by The People‘s Republic of
China (Alessandrini, 2009). A country could swap is foreign currency denominated
assets into the equivalent value of SDRs. For China, it could swap its U.S. dollar
reserve holdings with SDRs, effectively reducing its currency exposure of USD by 56%
(as the SDR is currently made up of 44% USD). This would help China maintain the
value of its reserve while the USD depreciates without directly affecting the market
value of the USD by dumping large quantities of them on the open market. The account
would be a reserve pool that is off market and would help countries (and possibly
MNCs) diversify their currency holdings. There are many challenges to implementing
this account, such as limitations, cost and liquidity issues for the underlying SDR
currencies. However, if the SDR is going to become a global currency, this step is
imperative as it facilitates utility of the currency as a means of payment.
Conclusion
This paper has argued that using a sovereign currency as a key currency is no longer
effective as the monetary system has moved from a fixed system based, to a floating
fiat system. Additionally, as central banks of the key currency sovereign would have
conflicting obligations to hold the currency value as a global reserve currency, or utilize
monetary policies to promote its own sovereign economy. Even if they do not, having
the ‗exorbitant privilege‘ of holding the key currency can lead to a global imbalance of
payments, where the country with the key currency becomes the deficit of last resort.
The USD as a global reserve and key currency no longer works, as evidenced by the
2008 financial crisis.
The SDR general allocations need to be reviewed before the SDR can move forward as
a global currency. The IMF hypothesizes that general allocations of 200 billion every
five years may work as trade increases (IMF External Relations Department, 2010).
This arbitrary quota needs to be revised and further research needs to be done. This
paper recommends these general allocations in addition to the substitution account. The
SDR allocations would be based on current account and balance of trade surpluses.
This could be introduced to make the SDR and international currency with a true store
of value. It would then be restricted from expansionary monetary policy leading to
inflationary periods or yet another financial crisis.
Increasing SDR holdings based on the current account surpluses of countries is
recommended and could be called a current account SDR system. This would help
fortify the innate value of SDRs as a currency, as the allocation of holdings would be
based on the accumulation of value above and beyond a country‘s consumption of
value. This paper argues that currency is not an asset or debt, but a holding tank for
value (like a battery holds energy) based on the production of goods and services. If a
country has a surplus as does China, they get the equivalent denomination of SDR
holdings (the asset portion of the SDR). If a country has a deficit as does the U.S. their
holdings are either decreased or their allocations of SDRs (the liability side of SDRs)
decreased. This could mean that surplus countries redeem their SDR holdings to invest
in infrastructure, education and their economy. Deficit countries would be inclined to
decrease their deficits or devalue their currency, and would not be reliant on the credit
of surplus countries. The reason the current accounts should be used to measure value
and SDR holdings is that with the lack of a fixed peg such as gold there is no natural
limitation to today‘s fiat floating monetary policy. Today‘s system gives sovereigns the
short term ability to create value out of nothing with the long term costs of devaluation.
This current account SDR system could be used in conjunction with a two tiered
monetary system that is joined by the SDR substitution account. The central banks still
could print money and apply independent monetary policies within their country that
would affect currency markets based on supply and demand of fiat currency. They
would have the IMF SDR account with its holdings and allocations that it could draw
upon for reserves. The value of each country‘s current account will be debited and
credited in terms of SDR allocations. The substitution account would allow for a country
to buy or sell SDRs based on its own currency value in relation to the SDRs. When a
country devalues its currency or takes on protectionist monetary policy, the amount of
SDRs it can purchase will be greatly reduced. Also, it would take more domestic
currency to purchase SDR holdings creating an indirect punitive system for protectionist
policies, facilitating global trade and commerce.
In order for global trade to prosper there needs to be confidence in financial markets.
The current financial crisis has impeded confidence in currency markets. This increases
currency risk for businesses transacting in international currencies, or operating
internationally. The current dollar based international monetary system is weak due to
the floating rate exchange policy of the USD combined with expansionary U.S.
monetary policy. The state of U.S. finances discussed in this paper has lead countries
to be bearish on the USD, and not wanting to be exposed to its volatility.
Other than the USD, other IMS reserve or key currency options were explored. The
Euro is the second most prominent global currency, but is still not ready to be the global
reserve currency. The Chinese Renminbi, another strong contender, has the same
problem, as it is not seen as an international currency but may become one in the
future, and be possible be included in the SDR basket (Rowley, 2011). Also, as China‘s
governor, Zhou Xiachaun stated, there are innate problems with any one country having
the great privilege of being both a sovereign currency and a reserve currency, as the
interests often conflict. Other currency alternatives were explored, including the gold
standard; commodity based currencies, Bancor, as well as Special Drawing Rights.
SDRs are a valid alternative and their history and current functions were discussed. The
political environments as well as the potential future of SDRs are speculated on. The
main obstacle for SDRs other than logistics and market acceptance is the United States
IMF vote. They can singularly veto the SDRs progression into a currency.
The vision for the SDR by the IMF was detailed as well as some discussion about how it
could be a true currency that holds value, a unit of measure and be readily acceptable
as a form of payment. Future research into a SDR current account and SDR substitution
account could be performed. Their potential role to facilitate a two-tiered international
monetary system based on SDR holdings (the asset) being issued is needed. The
issuance could be based economic value creation, measured by current account
surpluses as well as a currency exchange. Countries then retain their own currencies
and set their own monetary policies. Multinational companies would have the freedom
to invoice or transact in either sovereign currencies or SDRs. Even though there are
implicit challenges with this model, SDR as a global currency should be further explored
as an alternative to the current flawed IMS, especially how to minimize the credit
component. The growth of globalization and multinational business means we have
outgrown the old model, and need to embrace the changes to stabilize our currency
markets and thus stabilize international business.
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