A special moment for Special Drawing Rights

The recent annual meetings of the International Monetary Fund and the World Bank in Lima, Peru, were dominated by talk of the weakness of several emerging and developing economies. But the discussion focused very little on one key cause: the global monetary system. Much more will be said this month at the IMF board, though what the Fund will do remains an open question. The problem that emerging and developing economies are facing stems from the fact that their capital inflows follow a strongly pro-cyclical pattern. When they were growing rapidly – especially compared to the advanced economies – they attracted massive amounts of capital. But as risks multiplied, capital started to flow back toward a reserve-issuing country – namely, the United States. After all, the US is set to raise interest rates, and the dollar has appreciated against virtually all of the world’s currencies. In the past, this pattern has always ultimately led to a correction, with America’s growing current-account deficit eventually bringing about a dollar depreciation. But such corrections – in 1979-1980, 1990-1991, and 2007-2008 – have also always been associated with a global slowdown or crisis. This highlights the problem inherent in using the US dollar, a national currency, as the global economy’s primary international-reserve currency. The Belgian economist Robert Triffin first identified this problem – dubbed the “Triffin dilemma” – in the 1960s, emphasizing the fundamental conflict between national objectives, such as limiting the size of the external deficit, and international imperatives, such as creating enough liquidity to satisfy demand for reserve assets. Moreover, this system subjects the world economy to cycles of confidence in the US dollar, while placing the world economy at the mercy of a national authority – one that often makes decisions with scant regard for their international implications. The only way to stabilize the system would thus be to place a truly global currency at its centre. This was the idea behind John Maynard Keynes’s proposal in the 1940s to create a supranational currency, called the “bancor.” And it was the motivation behind the 1969 creation of the IMF’s Special Drawing Right (SDR), which was supposed to become “the principle reserve asset in the international monetary system.” General SDR allocations are to be based on “a long-term global need to supplement existing reserve assets,” with decisions made for successive periods of up to five years. So far, such allocations have been made only three times, in 1970-72, in 1979-81, and in 2009, with the latter allocation, amounting to US$250 billion, being part of the recovery package adopted by the G-20 to manage the global financial crisis. The SDR has been in the news again lately, owing to debate about whether the IMF should add the Chinese renminbi to the basket of currencies that determine the unit’s value. Given the renminbi’s growing international role, it seems abundantly obvious that the currency should be part of the SDR basket. Now, the discussion should focus on how to enable the SDR to reach its potential as an instrument of international cooperation. The first step toward making SDRs a more active force in global finance would be to remove the division between SDR accounts and normal IMF operations. As long as that partition remains in place, SDRs will function, at best, like a credit line that can be used unconditionally by the holder – a kind of overdraft facility, not a true reserve asset. A better approach would be to allow countries to “deposit” unused SDRs in the Fund, so that they can be used to finance IMF lending operations. In other words, issuing more SDRs would enable the IMF to finance more lending. If those SDRs were issued during crises, like the one that emerging and developing economies are confronting today, the result would be a truly counter-cyclical global monetary policy. This could even be taken one step further, with SDRs being allocated according to a new formula that accounts not just for IMF quotas, but also for demand (or need) for foreign-exchange reserves. The current formula would have the countries most in need of foreign reserves – that is, middle- and low-income countries (excluding China) – receiving just over one-third of the total allocation. That is not enough. Even without this change, the SDR can and should gain a more prominent position in global reserves. With emerging and developing economies in deepening trouble, there is no time to waste. Some five decades after Triffin first identified the problems with the US dollar’s reserve-currency status, the SDR’s moment has, one hopes, finally arrived.