THE SPECIAL DRAWING RIGHTS

SDRs were created by the International Monetary Fund (IMF) in

1969 to supplement the

stock of official reserves. The original intent of the program

was to revitalize the dying Bretton

Woods system by altering the composition of international

reserves between the scarce quantity

of monetary gold and the abundant stock of dollar liabilities.

The initial allocation of SDR 9.3

billion, over the 1970-72 period, failed to achieve this

objective. Not surprisingly, in 1971 the

gold convertibility of the dollar was suspended. A second

allocation of SDR 21.4 billion took

place from 1979 tom 1981 in the wake of the second oil shock.

Also this allocation failed to

achieve the intended results of stabilizing the dollar-based IMS.

After that, SDRs have played a

marginal role as international reserve, in parallel with the

declining importance of the IMF. The

SDR has remained mainly a unit of account, defined in terms of

fixed, but adjustable every five

years, quantities of a few important national monies. At the

moment, the basket includes the

dollar, the euro, the yen and pound sterling.

The G20 recommendation of a new SDR allocation worth $ 250

billion at the 2009

London meeting has brought back to front stage the SDR as an

international reserve asset. It is

the only official proposal to strengthen the IMS; hence, it

deserves careful examination not only

for its own merit but also for the prospect of a positive

evolution of the IMS. Policy makers have

underscored that the new allocation can be effected rapidly

because it is part of an existing

institution codified by the Articles of Agreement of the IMF.

They have also claimed that the

decision would create sufficient new international liquidity to

finance external imbalances and

set the IMF again back at the center of the IMS. In fact, the

London recommendation builds on

a weak scheme that has produced few results in the past.7

Furthermore, the size of the new

allocation is small relative to the size of the external

imbalances, especially those of the United

States. Finally, the very structure of the SDRs assigns to the

IMF a largely passive role.

To better understand the discrepancy between policy makers’

expectations and likely

outcome, we start by recalling that the “SDR is neither a

currency, nor a claim on the IMF.

Rather, it is a potential claim on the freely usable currencies

of IMF members” (IMF 2009).

Once a SDR allocation decision has been made, the IMF has no

discretionary power on how

SDRs will be used. Under the present system, exchanges of SDRs

for national currencies occur

either through voluntary bilateral transactions or through the

IMF that may designate member

countries with external surpluses to accept SDRs in exchange for

their currencies. Thus, the IMF

acts as a broker matching deficit to surplus countries to

exchange SDRs for international

monies. The transactions remain bilateral.

Each member country receives an amount of SDRs that is

proportional to its quota in the

Fund, without any necessary ex-ante consideration about the

external liquidity of the country.

After the allocation, a deficit country (DC) can swap SDRs for an

equivalent amount of

international money, say dollars, at a surplus country (SC). The

price of the swap is an interest

rate (equal to a weighted average of the money market of the four

currencies in the SDR basket)

paid by DC to SC. After the swap, DC has more dollars and less

SDRs; the opposite is true for

SC. DC can use the acquired dollars to intervene in the exchange

markets, while SC can use the

acquired SDRs to diversify the currency composition of its

international reserves. In essence,

the mechanics are those of a “giro system” aimed at stabilizing

exchange rates (Machlup 1968,

p. 13).

The SDR scheme is designed to activate hoarded international

money. The latter is

redistributed from SC to DC countries. But there is very little

that SDRs can do to improve the

position of the largest deficit and net external debtor country

in the world. The United States is

unique in both the size of its external imbalances and as a

provider of the dominant international

money. The US share of the new SDR 250 billion is paltry relative

to the size of the US external

imbalance. To make a dent on the problem would require a large

allocation only for the United

States. Under such circumstances, the Fed could exchange SDRs for

dollar assets at SCs,

starting from the dollar-rich People’s Bank of China, and reduce

the high weight of dollars in

official reserves.8 But apart from the large size of SDRs

involved, the bilateral SDR-dollar swap

would be incapable of making the necessary adjustment required to

mop up the “excess” supply

of dollars. The swap, in fact, would leave the size of the US

monetary base unchanged (only the

composition would change in favor of domestic assets). To effect

a reduction of the US

monetary base, the Fed would have to sell in the market place the

T-bills received from SCs in

exchange of SDRs. The Fed and the US government would have to

explicitly agree to such a

policy.

The basic idea of using SDRs as a replacement for dollar-

denominated assets held by

central banks was taken up in the Seventies by the Committee of

Twenty (1974). The latter

produced a proposal, known as the Substitution Account, which was

later evaluated by the

Interim Committee of the IMF in 1978-79. Under the proposal,

central banks could open an account denominated in SDRs by

depositing dollar assets at the IMF. Thus, SDRs would be created

endogenously by the actions of those central banks that deemed to

have too many dollar assets in their official reserves.

In contrast, the existing SDR scheme envisions only exogenous

supply increases. The Substitution.

Account never came to light because neither the IMF nor the

United States were willing to bear

the exchange rate risk arising from an unhedged position of the

Fund having dollar assets and

SDR liabilities (Boughton 2001, ch. 18). Had the Substitution

Account been implemented, we

would have avoided the large overhang of dollar reserves that now

threatens the durability of

the international dollar standard.

The importance of reforming the existing SDR mechanism in a

supernational direction

has been raised recently by Zhou Xiaochuan (2009), the Governor

of the People’s Bank of

8 In the balance sheet of the Fed, the exchange would imply a

reduction of SDRs and an equivalent

increase of dollar assets (T-bills).

China. China, more than any other country, is exposed to the risk

of an implosion of the dollar

standard and feels urgently the need to diversify out of dollar

assets. Given that the yuan is not

an international money, there is an obvious Chinese interest in

seeing the transformation of the

dollar standard into a supernational money standard. As we have

mentioned it in the

introduction, Mr. Xiaochuan has chosen to endorse the SDRs and

has suggested at the same time

a series of recommendations that would make them converge

progressively to a supernational

money. Among the recommendations, it is worth mentioning the

following three: transforming

the SDR from an artificial basket currency into one backed by

assets; establishing a settlement

system between the SDR and national currencies so as to make the

SDR a fully fledged money;

and linking the SDRs to a specific institution that would be

responsible for their management

and their value, in other words becoming someone’s liability.

The current situationWhile there was broad support for the special one-time allocation

of SDRs with a 77 per cent vote (excluding the USA) the political

support for a broader regular allocation of additional SDRs is

lacking, especially from the industrialized nations. This is

partly because the original driving force behind the SDR idea –

the provision of an additional reserve asset in a world of

limited reserve asset supply – assets meant gold and dollar in

the 1960s – no longer holds.

Since the breakdown of the Bretton Woods system and the advent of

freely exchangeable floating exchange rate systems for the

industrialized countries, the supply of reserve assets has not

been limited.As well as gold and the US dollar, the euro, pound

sterling and Japanese yen are now widely held as reserve assets.

Since these are all freely tradable in the markets, their supply

is not constrained and countries can make decisions about the

level of reserves to hold.This at least is the theory.Yet many

developing countries find it hard to buy and hold reserve assets.

There are two ways in which developing countries can build up

reserves: either by running a balance of payment surplus (excess

of exports and capital inflows over imports and capital outflows)

or through borrowing in the international financial markets. Not

only do both have large associated costs, but many developing

countries find it difficult to build up reserves even if they are

willing to pay the costs.

Countries can build up reserves through exporting more than they

import but this can entail high costs in terms of foregone

consumption and investment. These costs are especially

significant for the least developed countries (LDCs). Having high

capital inflows is another way of building up reserves but these

inflows are concentrated in only a few countries such as China

and other countries in East Asia and hence cannot be a dependable

source of building up reserves for most developing countries.

Countries may borrow to build up reserves but these have large

associated costs even in the cases where this is a viable option.

Most developing countries do not even have access to capital

markets and no private creditor would be ready to lend to most of

the LDCs at anything less than extortionate and clearly

unaffordable interest rates.

Hence developing countries continue to encounter serious problems

in terms of building up sufficient reserves at reasonable costs.

How Gold Will Be Added to the SDR Basket Valuation

By JC Collins

Sometimes what at first appears to be conflicting information is

anything but, and what was originally considered to be opposing

forces or ideals can quickly become unified for the greater

good.There has been much discussion and division over whether the

world was moving towards a multilateral super-sovereign reserve

currency by way of the Special Drawing Right of the International

Monetary Fund or towards a new gold standard by which all

currencies would be valued once again on gold.Positions have

taken up defense on both sides and all waited to see which side

was going to be right.  Were the BRICS countries going to

overthrow the western banking cabal?  Was the US dollar going to

inflate into oblivion?  Was the SDR going to become the new

reserve currency?  Was a new gold standard going to be

implemented instead?

So many questions with no clear outline or determinations on what

exactly was going to happen.

I have contested all along that the SDR was going to become the

super-sovereign reserve currency of the emerging multilateral

financial system.  The supporters of a new gold standard have

found this idea unworkable because gold is considered to be the

only method of creating stability within the larger architecture

of the global financial system.

But what if everyone is right?  Or more correctly, what if all

the obvious points and leverage of each potential system can be

utilized to create the larger macro stability from which the

multilateral will inevitably emerge?

In the post Renminbi is Already a De Facto Reserve Currency, I

discussed how the Chinese currency was being internationalized

and would be added to the SDR basket valuation.

This basket is currently made up of four currencies, being the US

dollar, the Japanese yen, the Euro, and the British pound. 

Adding the renminbi to the basket is both important and necessary

for any changes to the global financial architecture.

But this theory has never accounted for the importance obviously

placed on gold and the manipulation and mass movement of the

precious metal which has taken place over the last few years.

No doubt the gold moving east has a lot to due with balancing old

sovereign bond debts and building up reserves to support the

renminbi denominated contracts which have just begun at the

Shanghai Gold Exchange.

But this doesn’t fully explain the demand by other countries for

gold, such as Russia and India, or even Germany demanding its

gold back from the United States.

But nether does a gold standard fit the facts as all

participating countries and economies have stated in official

publications and speeches that a new gold standard is unworkable

and the SDR provided the best opportunity moving forward to

balance the financial structure of the world.

I have attempted to explain and describe how the BRICS countries

are aligned with the larger macro mandates of the SDR

multilateral system and do not plan on overthrowing the western

banks.  It is in fact a situation where the western and eastern

banks are all controlled by the Bank for International

Settlements.

It is interesting that over the last few days even certain

conspiracy theorists which have been promoting the overthrow of

the western banking cabal are now stating that the BIS and its

central bank system will remain.

In most of my more esoteric posts I explain how the human mind

seeks out division and from that division is born conflict.  Once

symbols of division have been established it is almost impossible

to shift the thinking of each position to see or observe a larger

or more unified macro picture.

But once that realization is made the conscious thought pattern

of all things takes a leap forward and what was once hidden in

plan site becomes clearly visible and clarity resumes.

As we move closer to the end of this year and the ultimate point

of transition to the multilateral, it is important to continue

studying and observing the patterns which are taking place on the

micro level.  These proxy resource wars and attempts to

consolidate resources under regional currencies before the larger

macro consolidation takes place will likely taper off as

agreements are made and positions relinquished.

The US Congress will pass the required legislation to enact the

2010 IMF Code of Reforms which will allow for the necessary

changes to the Executive Board of the IMF to take place.  This

will also allow for the SDR basket to be opened and the renminbi

and gold will be added to the overall valuation.

So once completed, the SDR basket valuation will consist of the

following stores of value:

US Dollar

Japanese Yen

British Pound

Euro

Renminbi

and Gold.

From this point we need to study and observe the massive amount

of Sovereign Wealth Funds which litter the background of the

international financial architecture.

Energy exporters and pacific rim economies which have undervalued

currencies have been pouring investment into SWF’s.   These funds

are in a perfect position to promote the use of the SDR as a unit

of account and store of value.

In the coming months and years you will see Sovereign Wealth

Funds begin to purchase large amounts of SDR denominated bonds

and securities.  This is likely where the solution to the

derivatives issue will be found.  Somewhere in between Sovereign

Wealth Funds and SDRM – Sovereign Debt Restructuring Mechanism,

will be found the answer.

This will be the “reserve dollar” exit strategy for central banks

and national treasuries.  – JC

Proposals for SDR usage

There have been several proposals for reinvigorating SDRs in

recent years for various purposes that range from reserve

allocation to poverty reduction and the provision of global

public goods

In the mid-1980s, executive directors from India, Belgium and

France each sponsored a slightly different plan under which

creditor countries would lend to the IMF the SDRs allocated to

them, for use by the IMF to lend to developing countries.

In 1988, President Mitterrand of France proposed that the

developed countries contribute their shares in a new allocation

of SDRs to a special fund in the IMF that would guarantee the

interest payments on certain obligations issues by debtor

countries.

More recently, ideas were put forward to use the SDR mechanism to

enable the IMF to provide more credit under situations of

financial stress for its members. A task force sponsored by the

Council on Foreign Relations suggested the formation of a new

“contagion facility” for providing funds to tackle the recurrence

of a financial crisis of South East Asian crash dimensions. It

suggested that this facility should be funded through a one-off,

very large ($45-$100 billion) allocation of SDRs that was then

donated to the facility by all the member countries.

Richard Cooper suggested that the IMF articles should be amended

to provide it with sufficient resources to cover even the worst

contingency. The amendment would need to confer the IMF with the

right to create SDRs on a temporary basis as needed to deal with

financial crisis and forestall creditor panic.

This position is broadly shared by IMF staff and was implicit in

a proposal made in 1993 by the then managing director, who

proposed a general allocation of SDR 36 billion for increasing

the supply of reserve assets at reasonable costs. But the

proposal did not get the required 85 per cent support. A recent

IMF working paper suggests the resumption of regular SDR

allocations for the above purposes. The financier George Soros

has suggested that SDR allocations be used to provide global

public goods

He argued that:

• The IMF articles of agreement, as they stand, only allow for

SDR allocations that are distributed to all member countries – in

other words, to develop as well as developing countries.

• If the Fourth Amendment were implemented, the developed

countries should donate their share of $18 billion of the

allocated SDRs to help finance development assistance through the

provision of global public goods.

• An independent board would determine which programmers would

be eligible to receive SDR donations, but the initiatives and

programmers would be generated from developing countries

themselves.

• SDR donations should be used in the first instance for the

fight against communicable disease, particularly AIDS and TB, for

education, judicial reform and initiatives to close the digital

divide.

Other commentators have suggested that the IMF use SDR

allocations to cancel some of the debt owed by poor countries.

All of these proposals have some merit and deserve further

consideration. But it is important to distinguish the different

motivations and impacts implicit in the different proposals. The

ideas put forward by the Council for Foreign Relations and

Richard Cooper both call for the use of SDRs to deal with

contingencies. Under normal circumstances, these do not entail

any additional costs for the developed countries whose currencies

are exchangeable for SDRs. This is because, under normal

conditions of the world economy, the SDRs would not be exchanged

for other currencies and would only constitute a nominal not real

transfer.

The ideas proposed by India, Belgium and France in the 1980s, to

use SDR allocations for conditional lending or guaranteeing some

debt obligations, are again likely to have few incremental costs

for the industrialized countries. Proposals by the IMF staff and

the Zedillo commission are very attractive and entail significant

savings for developing countries that may be as high as $100

billion per year. New allocations of SDRs would have to be re-

directed to poor countries, with the agreement of the rich –

under the current rules, new allocations will not go

automatically to the countries that need them.

Comparison between SDR and GOLD:

IMF’s Special Drawing Rights (SDRs): (Based on London Markey)

Special Drawing Rights (SDRs) were created by the IMF in 1969.

Originally, the value of an SDR was defined as equivalent to

0.888671 grams of fine gold (0.028571oz) which, then, was also

equivalent to a US dollar (1oz of gold = 35 SDRs = US$35).

Anyhow, after the gold exchange standard, commonly called Bretton

Woods in 1973, SDRs have been redefined as a basket of

currencies, today comprising of euros, Japanese yens, British

pounds and US dollars. The SDR rate in US dollars is posted every

day on the IMF’s website. It is calculated as being the sum of a

specific amount of the four currencies in the basket, rated in US

dollars based on the exchange rate fixed at noon, each day, on

the London market.

Gold vs. Special Drawing Rights Gold in SDRs:

Since December 2010, the value of one SDR equals the sum of 0.423

euro, 12.1 yens, 0.111 British pound and 0.66 US dollar. On

February 21, 2014, one SDR was worth $1.542905, an ounce of gold

was worth 857.75 SDRs, and it was worth $1,323.25. This clearly

shows the devaluation of paper currencies compared to gold since

1971 (-2,450.71%).

According to the statutes of the IMF, member countries are

forbidden to tie their national currency to gold. This is the

reason why Switzerland was forced, when it became an IMF member

in 1992, to abandon its 40% gold coverage of its currency which

was until then written in its Constitution. SDRs are neither a

currency, and neither are they IMF-issued credits. It is rather a

potential claim on the free-floating currencies of the IMF

members. China is the only one of the six large world economies

whose currency (Yuan) does not have reserve currency status

Robert Mundell’s INTOR:

It seems that there are secret negotiations going on at this

moment under the auspices of the IMF and the Bank for

International Settlements (BIS) in order to prepare for a new

international monetary system. Many scenarios exist, from

creating an international paper currency, still based on a basket

of currencies like the SDRs (chart #2), but that would include

the Chinese Yuan and other currencies from developing countries

(Russian ruble, Indian rupee, Brazilian real, South-African

rand), to an SDR that would also include a percentage of gold

(charts #3 and #4). Robert Mundell, Nobel Prize laureate in

economics, was already proposing an international currency in

1998, the INTOR, comprising 50% of gold and a basket of paper

currencies (chart #3), while Dubai’s DIFC, in a 2010 study, was

proposing 20% in gold.

ll of those scenarios pre-suppose preparations, along with an

international conference, before a major monetary crisis occurs.

Obviously, the current system has been quite profitable for the

United States, and that it does not wish for profound changes.

« The dollar may be our currency, but it’s also your problem ».

This U.S. position, aptly expressed in 1973 by John Connally,

U.S. Treasury Secretary, in a speech to Europeans, still seems to

be predominant today.

It is impossible now to know what system will be chosen, or which

one will impose itself, because it all depends on the chain of

events that will trigger the end of the current (dollar) system

based on debt (mainly U.S. debt). The United States will be the

last country to accept a reform that would eliminate the

(exorbitant privilege) offered by the present system and it will

make no proposition to stray from the current system. This system

maximizes its stronghold. It is however certain that the gold

price will rise sensibly until a new monetary system is in place.