Do we need a new global currency?
Most people have forgotten what SDR’s are (if they ever knew). Like dollars or any other currency, the SDR is both a unit of account and a means of payment. The value of the SDR was originally defined as the market value of 0.888671 grams of fine gold, which in 1969 was equal to one US dollar.
Currently one SDR is the market value of a basket of 0.632 US dollars, 0.41 euros, 18.4 Japanese yen and 0.0903 pound sterling. At the time the current basket was adopted (1 January 2006 – its valuation basket or method of valuation is reviewed and adjusted every five years) these amounts reflected weights of 44 per cent for the US dollar, 34 per cent for the euro and 11 per cent each for the Japanese yen and pound sterling. Over time these weights vary with the exchange rates of the fixed currency amounts in the basket. The US dollar values of the amounts of each currency in the valuation basket are determined in the market each day and added up to determined that day’s value of the SDR (see the table below).
All of the IMF’s financial activities, in particular its loans, are valued in SDRs. These SDR denominated loans are not SDR proper any more than US Treasury bonds are US dollars proper. The SDR amount of credit due to the IMF varies over time as its lending activity varies. IMF loans are actually disbursed to borrowing central bank largely in member currencies (primarily US dollars), but the obligations are denominated in SDRs.
What we might call the SDR proper, the SDR denominated reserve asset allocated by the IMF, the SDR the governor of the Peoples Bank of China was referring to, has played a very limited role to date. Prior to the new allocation of SDRs in August 2009, the IMF had only issued SDR 21.433 billion of them (the equivalent of about 32 billion US dollars at current exchange rates). For perspective, this might be compared with the amount of credit directly created by the Federal Reserve (Federal Reserve Credit) of about $2 trillion dollars over most of 2009 or the 250 billion US dollar allocation last August. The new allocation, by raising the stock of SDRs from 21.4 billion to $271.4 billion, will provide a very big boost to the SDR.
An SDR allocation is similar to a line of credit. SDRs are ‘allocated’ to IMF members in proportion to their quotas in the IMF, which roughly reflect their economic size and importance in world trade. Allocated are credited to the SDR account with the IMF as additional SDRs owned and held by each receiving member. At the same time the member’s SDR account with the IMF will record a liability for the same amount. The member will earn interest at the SDR interest rate on whatever SDRs it holds and must pay interest at the same rate on its SDR liabilities. If it continues to hold the SDRs it was allocated, the member will earn the same interest income that it pays on its allocation.
In short, if it does not use any of its SDRs and does not acquire additional ones in payments from other IMF members or other holders or buy them, its interest income on its SDR holdings and payments on its net cumulative allocations will be equal and will thus cancel out. The member will enjoy larger foreign exchange reserves at no cost, but with no net interest return. If the member uses 100 million of its SDRs, for example, its interest income will fall by that amount times the SDR interest rate, but its charges for its net cumulative allocation will remain unchanged, other than from changes in the SDR interest rate. In short, the member would then have a net charge to the extent of its net use of its SDRs. This is the sense in which an SDR allocation is like a line of credit without the commitment fee or risk of cancellation. Conversely, if the member acquires additional SDRs from other central banks so that its holdings of SDRs exceed its net cumulative allocation, it will enjoy net income to that extent at the SDR interest rate.
If the demand for SDRs equals or exceeds their supply, countries can use their SDRs directly. The Chinas of the world, with foreign exchange reserves of $2 trillion, mostly in US dollars, would be happy to accept and hold SDRs in payment for another country’s financial obligations or to buy them (rather than dollars) for dollars. Most countries using their SDRs first converted them into dollars by selling them for dollars to another central bank in so-called ‘Transactions by Agreement’. However, the system also has a mechanism, so called ‘Transactions with Designation’, by which countries with a strong balance of payments can be designated to buy SDRs for dollars, or euros (or another freely useable currency) when a holder wishing to sell them for currency cannot find a buyer in a Transaction by Agreement. Official SDRs may also be lent, swapped and sold forward.