Understanding Special Drawing Rights (SDR)

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Number Pb09-11 juNe 2009

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Understanding SpecialDrawing Rights (SDRs)

John Williamson

John Williamson

, senior ellow at the Peterson Institute, has beenassociated with the Institute since 1981. He was project director or the UN High-Level Panel on Financing or Development (the Zedillo Report) in 2001; on leave as chie economist or South Asia at the World Bank during 1996–99; economics proessor at Pontifcia Universidade Católica do Riode Janeiro (1978–81), University o Warwick (1970–77), Massachusetts Institute o echnology (1967, 1980), University York (1963–68),and Princeton University (1962–63); adviser to the International Monetary Fund (1972–74); and economic consultant to the UK reasury (1968–70). His numerous publications include

Reerence Rates and theInternational Monetary System

(2007) and

Dollar Adjustment: How Far? Against What?

(2004).Note: Te author wishes to thank C. Fred Bergsten and Edwin M. ruman or helpul comments on an earlier drat o this policy brie. He is solely responsible or any errors that remain.

© Peter G. Peterson Institute or International Economics. All rights reserved.

A once-amiliar but long-neglected acronym has reappearedin newspapers in recent weeks. We have read that the G-20meeting in London endorsed a proposal that the InternationalMonetary Fund (IMF) should create $250 billion in SpecialDrawing Rights (SDRs). We have been told that one problem with this proposal is that most o the SDR allocation wouldaccrue to countries that are unlikely to use them, and somereaders may have seen proposed ways around this diculty. We have read that the governor o the People’s Bank o China,Zhou Xiaochuan, has proposed that the SDR should gradually displace the dollar at the center o the international monetary system and that surplus countries should be able to converttheir dollar holdings into SDR-denominated assets. No one candoubt that the SDR is back.But what is an SDR? Yes, SDR stands or Special DrawingRight, but that hardly answers the question. How and why didthe SDR originate? How did it get its strange name? How many are there, who holds them, and what can they be used or? Dothe rather-distinct proposals outlined above all reer to the sameanimal? How are these proposals interrelated? Can one specu-late useully about the uture o the SDR? Tis policy brie aimsto answer such questions.

History

In 1960 one o the most original analysts o the postwar inter-national monetary system, the Belgian/US economist Robertrin, published a small volume with a big thesis called

Gold and the Dollar Crisis

.

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He argued that the system that had beenagreed at Bretton Woods and had just come into operation would not last because its inner workings contained an internalcontradiction. Apart rom gold, whose supply was small anderratic, the increase in demand or international liquidity couldbe satised only i the reserve center, the United States, ran apayments decit to supply more dollars to the world. But suchdecits were bound to undermine condence in an unchangedlink o the US dollar to gold. Te rin Dilemma posited thatthe world thereore conronted a choice between running shorto liquidity and undermining condence in the dollar, which was destined sooner or later to produce a crisis. Analysts argued that the system had other problems, suchas the lack o a crisis-proo adjustment mechanism as a resulto widespread unwillingness to change exchange rates except asa last resort. But ocials decided that the problem they couldsolve best, or at least the one they would solve rst, was therin Dilemma. Teir solution was to create a synthetic reserveasset to supplement the supply o gold. Its price was xed interms o gold at exactly the same level as $1, so that SDR1= $1. Because o a continuing disagreement over whether thenew reserve asset should be considered money (“paper gold”) orcredit (since countries receiving assets had to reconstitute a parto their endowments in due course), it was given the anodyne

1. Robert rin, 1960,

Gold and the Dollar Crisis: Te Future o Convertibility

,New Haven: Yale University Press.

Policy Brief

Number Pb09-11 juNe 2009

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name, Special Drawing Right. Hence we still live with the termSDRs.Te rst SDRs, 3 billion o them, were created and allocatedamong members o the IMF in proportion to their quotas on January 1, 1970. Te rationale or making, by the standards o the time, such a sizeable allocation was the prospect o a reserveshortage as a result o stringent US monetary policy in 1969.Further allocations o approximately SDR 3 billion a year wereagreed simultaneously or the ollowing two years: Te actualallocations were SDR 2.9 billion in 1971 and SDR 3.4 billionin 1972. At the end o that process the SDR constituted some9.5 percent o the world’s stock o nongold reserve assets.However, beore the last o these allocations had occurred,the world was no longer short o liquidity. Monetary stringency had led to a US slowdown, and the US Federal Reserve, seeingthat this posed a threat to the president’s reelection, stepped onthe monetary accelerator. Tis resulted in an explosion o inter-national liquidity and the breakdown o the Bretton Woodssystem, and in 1972 the IMF convened a Committee o wenty (C-20), based on the 20 constituency chairs then operative inthe Fund, to agree on an appropriate reorm o the internationalmonetary system.Te state o thought at the time can be gleaned rom aconerence convened by the IMF in 1970 to discuss the criteriathat should govern reserve creation. Te prevailing view saw theIMF as essentially controlling the world’s reserve base, consistingo a more-or-less xed supply o gold plus a consciously variablequantity o SDRs. Countries would choose to hold dollars andsecondary reserve currencies in a airly xed relationship to theirholdings o primary reserve assets and they would issue domes-tic money more or less in proportion to their reserve holdings.Hence by varying its issues o SDRs the IMF could determinethe monetary evolution o the world. Tis being the heyday o monetarism versus Keynesianism, the big bone o conten-tion was whether the IMF should allocate SDRs so as to securean equilibrium long-run monetary growth rate independento short-run uctuations in aggregate demand or whether itshould try to engage in short-run countercyclical ne-tuning.Te monetarists won, and so the IMF continued to determinethe rate o SDR allocations or multiyear “basic periods,” basedon prospective shortages o reserves.Te Europeans came to the C-20 assuming that its mandate was to secure such a world. But it turned out that Europeanpreoccupations were not shared by others. First, the UnitedStates was not prepared to consign the advantages it accruedrom issuing the world’s reserve currency, at least not withoutmuch-stronger assurances that it could rely on the rest o the world to adjust when needed, which it sought to achieve by theinstitution o a “reserve indicator” system. Under such a systemeach IMF member would have been assigned—there was noagreement on how—a target level o reserves and would havethen assumed an obligation to adjust so as to keep its reserves within some limits around this target. Specically, i reserveshit an upper limit o some specied, proportionate diferencerom the reserve target, the country would have been obligedeither to revalue or to take other adjustment measures. De-cit countries would have been under a symmetrical obligationto adjust i they hit a lower reserve limit. Second, in an early exing o its muscles, the developing world was prepared toenthrone the SDR only in return or an “aid link.” Under such asystem a disproportionate share o new SDR issues would haveaccrued, directly or indirectly,

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to developing countries, withthe result that they would have been net debtors to the SDR account, just as the United States is a net debtor in dollars undera dollar-based system. Since the major powers could not agreeon objectives, the C-20 did not reach any agreement, and theinternational monetary system evolved into the largely rulelessarrangements o the past 35-odd years.However, there was a urther important developmentregarding the SDR during the period o the C-20. When it wasnally conceded in 1973 that the breakdown o the Bretton Woods system was permanent and that the exchange rates o the major currencies would oat against one another in theuture, the previous practice o valuing the SDR in terms o only one currency, the US dollar, appeared distinctly anoma-lous. Te only viable alternative in a system o predominantly oating exchange rates was to value the SDR as equal to a basketo currencies. In the rst instance this basket consisted o the16 currencies whose issuers each accounted or more than 1percent o world exports. Tis basket was subsequently revisedto the G-5 currencies, and it is now a basket o our, since theFrench ranc and the Deutschmark have both been merged intothe euro. Since 1972 the IMF has used the SDR as its basic unito account, so that all the Fund’s transactions are denominatedin SDRs.Te IMF has periodically debated whether to create addi-tional SDRs, but with one exception it has always concluded thatthe additional reserves stemming rom the US decit obviated

2. In one version o the aid link, newly issued SDRs would have gone tomultilateral development banks like the World Bank.

There are now 21.4 billion SDRs inexistence. As a proportion of totalworld (nongold) reserves, this isless than a derisory 0.5 percent.

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a reserve shortage that would justiy additional SDR creation.Te lone exception occurred in 1978, when major reserve hold-ers did not wish to increase their dollar holdings. Instead, there was active consideration at that time o creating a substitutionaccount at the Fund. Tis would have entitled reserve holders tosell dollars to the Fund in exchange or an equivalent amount o SDRs at the current market exchange rate. According to normalpractice, the Fund would have thereby obtained an SDR claimon the United States, and hence the United States would havebeen obliged to pay the Fund sucient dollars to make up orany subsequent depreciation in the value o the dollar in termso the SDR (just as the United States would have proted by any subsequent appreciation o the dollar, which in act happened).But the United States wished to have a dollar-denominateddebt, and this diference remained to the end. However, there was sucient suspicion o the dollar at that time to make mostreserve holders reluctant to accept more dollars, and so a new SDR allocation was agreed. Te basic period agreed was againthree years (against the ve years that were supposed to benormal), and the issue was to be about SDR 4 billion per year.Tere has periodically been debate about the value o creat-ing a reserve asset that would principally accrue to those coun-tries with large IMF quotas (the industrial countries) ratherthan to those in need o additional reserves (largely the develop-ing countries). It has been suggested that this could be avoidedby having the industrial countries donate their excess reservesto a pool that could be tapped by countries in need. Severalquestions can be raised about such proposals. First, would suchtransactions be legal under the present IMF Articles? Opinionsdifer, but i not, the proposal would require a new amendment.Second, because the SDR is an interest-bearing asset, countriesthat tap such a pool would need to accept responsibility orservicing the SDRs they receive, unless this is to be anotherorm o aid.

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Would advanced countries trust developing coun-

3. Admittedly the interest rate is low, being the average o dened money-mar-ket rates in the currencies that compose the SDR basket. Te standard analysisis that countries benet nancially rom receiving an SDR allocation because

tries to service the SDRs tapped rom such a pool, or wouldthey regard deault as a possibility? Tird, some way o distrib-uting the SDRs in the pool among claimants would need tobe devised. One method would be to distribute these SDRs inproportion to IMF quotas, though this would imply acceptanceo the legitimacy o the IMF’s quota arrangements and wouldmake the division between donors and recipients a criticalmargin. Further, some advanced countries might have reserva-tions about making their share o an SDR allocation available tocertain developing countries.In 1997 the IMF agreed on a Fourth Amendment tothe Articles, which involved doubling the quantity o SDRsoutstanding. Te additional allocation o SDR 21.4 billion would have been distributed in such a way as to bring eachcountry’s cumulative allocation up to the same percentage as its1997 quota. Tus the bulk o the allocation would have beendistributed to members that had joined ater the earlier alloca-tions, principally the ormer communist countries. However,amending the Articles requires an 85-percent majority approval,and since the United States has a quota o about 17 percent,it efectively has a veto over such actions. Because the USCongress has not yet ratied this amendment (i only becauseCongress has not previously been asked to ratiy it), the amend-ment has not come into efect and countries have not receivedthe additional SDR allocations that were agreed. Tis is oneo several IMF reorms requiring congressional action that theObama administration has recently submitted to Congress orapproval.

Basic Facts

Tere are now 21.4 billion SDRs in existence. As a proportiono total world (nongold) reserves, this is less than a derisory 0.5percent. Tey were originally distributed in proportion to coun-tries’ IMF quotas on the dates o allocation, but since then they have tended to gravitate rom developing countries in decittoward industrial countries in surplus. When a country wishesto use some o its SDRs, it nds a country (or the IMF) that is willing to receive the SDRs and supply a reserve currency (inpractice the US dollar) in exchange; SDRs cannot be spent inthe market. When the SDR was rst created, countries had a duty tohold, or i necessary rebuild, some proportion o the SDR allo-cations they had originally received. In 1981 this “reconstitutionprovision” was abrogated, which is slightly less denitive thanbeing abolished. It was argued that this marked a step toward

they get a long-term loan—even i they have limited creditworthiness—at theshort-term interest rate o the most creditworthy countries.

The dollar system bestows on the UnitedStates what the French, in the days of President de Gaulle and his economicmaestro Jacques Rueff, used to describeas the “exorbitant privilege” of payingits debts in its own currency.

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