SDRs – a new world reserve currency?

In a clause in a communiqué issued by the G20, a revolution in global finance was announced: a world currency outside the control of any single government. David Stevenson reports.

Why is the IMF in the news?

“If there was a real victor from the G20 summit… it has to be the International Monetary Fund,” says The Daily Telegraph’s Edmund Conway. The IMF “has gone from being a universally derided fossil from the Bretton Woods era to being the true nexus for efforts to remodel the world economy”. The fund’s overall kitty will treble to $750bn (£510bn), and it is also set to take a more proactive role in ‘bailing out’ troubled countries, by extending loans before real trouble hits. However, the most surprising change – a decision to allow the IMF to print $250bn worth of special drawing rights (SDR) – could, some believe, see it play a role in establishing a new global reserve currency.

What are SDRs?

SDRs were created in 1969 as an international monetary unit to support the Bretton Woods system of fixed-exchange rates. The value of the SDRs is set daily using a basket of four major currencies: the euro, Japanese yen, sterling, and US dollar. The SDRs are distributed between members in proportion to the subscription fees (or quotas) the country pays into the fund. “SDRs are counted as part of government reserves and may be used as collateral for borrowing, meaning that their creation in effect can mean increasing the global money supply,” says Alan Beattie in the FT. Although they’ve been around for a while, SDRs have been largely dormant, used as little more than an accounting unit between governments and the IMF, says Beattie. That is, up until now.

What’s changed?

“A single clause in Point 19 of the communiqué issued by the G20 leaders amounts to revolution in the global financial order,” says Ambrose Evans-Pritchard in The Daily Telegraph. In agreeing to support an SDR allocation that will inject $250bn into the world economy, “the G20 leaders have effectively activated the IMF’s power to create money and begin global ‘quantitative easing’ [printing money], putting a de-facto world currency, outside the control of any sovereign body, into play”.

Why is this revolutionary?

The US dollar is currently the world’s reserve currency, ie, it’s held by many governments as part of their foreign-exchange reserves. But that status is being threatened by China, America’s biggest creditor, which is becoming “concerned” about the safety of the $1trn in US government debt it holds. American national debt, including social security obligations, has grown to more than $11trn, above 80% of GDP and its highest level since World War II. That’s likely to see US Treasury yields forced higher to attract investors willing to fund this soaring deficit, which will hit bond prices, hurting the value of China’s existing holdings. On top of this, the Federal Reserve is printing money like mad to prop up the economy. Ultimately, many more greenbacks in circulation means the price, ie, the exchange rate, is likely to fall. Again, that’s bad news for anyone outside the US who is holding on to dollar assets when the currency falls.

So what are big US creditors doing?

To protect their long-term position, both the Chinese and the Russians have started talking about IMF-run SDRs replacing the buck as the world’s reserve monetary unit. Russia will now “ask the IMF to study the risks and possibilities” of a new global currency, said Kremlin chief economic adviser Arkady Dvorkovich this week, and the finance minister, Alexei Kudrin, will be pushing for a follow-up at the Washington IMF meeting later this month.

SDRs: is this feasible?

“I don’t believe that there’s a need for a global currency,” said US President Barack Obama last month. And little wonder. The US sees many benefits from having the reserve currency, such as being able to print the money that every other country needs to buy vital traded goods, such as commodities. It won’t be keen to just give it up. And there’d be several technical hurdles. SDRs would need promoting in foreign-exchange trading, international trade invoicing and as a currency in which private international financial deals like loans, bonds and deposits are denominated, says Reuters’ Swaha Pattanaik. Agreeing a wider basket of currencies on which to base the SDRs would also take some negotiation. But the once-taboo subject of the end of dollar dominance has been brought into the open. And given that China holds almost 30% of the world’s entire reserves, as HSBC’s David Bloom says, “what they say matters”. And even if SDRs don’t replace the dollar, the Chinese aren’t waiting for the IMF.

What is China doing?

China isn’t waiting for SDRs to become the new dollar. Right now its currency – the yuan, also known as the renminbi – is tightly controlled and not freely tradeable in international markets. But China is starting to use the yuan to settle trade accounts between some of its provinces and neighbouring states, starting with Hong Kong. “In a series of baby steps”, says the Los Angeles Times’s Don Lee, “Chinese officials recently have moved to globalise the yuan and promote its influence overseas, with Shanghai designated as command central”. Since last December, China has signed deals with six countries, including South Korea, Malaysia and Argentina, for currency swaps that would inject Chinese money into foreign banking systems, and allow foreign firms to pay for goods they import from China in yuan, so bypassing the buck.