Why SDRs should be abolished

Special Drawing Rights - created as a reserve asset 50 years ago - should be scrapped and the US dollar should be recognised as the world's sole reserve currency

Special Drawing Rights (SDRs) are an international reserve asset created by the International Monetary Fund (IMF) in 1969 to support the Bretton Woods fixed exchange rate system. After the collapse of the fixed exchange system in 1971, the SDR was redefined as a basket of select currencies. The US dollar value of the SDR was calculated as the sum of specific amounts of four currencies valued in US dollars based on the exchange rate quoted at noon each day in the London market. It has limited uses, such as determination of fees by the International Postal Union and as a spin-off, to determine roaming charges for mobile telephones in certain regions, except Europe.

In 1971, when the United States faced balance of trade deficits, the then US President Nixon took two major decisions: to end the war in Vietnam; and second, the US would no longer exchange dollars for gold at the fixed exchange rate of $35 per ounce of gold. The SDR should have been abolished after this development.

While Nixon took these steps to protect US interests, Willy Brandt, then Chancellor of West Germany, suggested that the members of the European Community should join a “common float” against the dollar. The euro should therefore be seen as an expression of the ego of the European allies, who were not consulted by President Nixon beforehand.

The SDR basket of 16 currencies from 1974 to 1980 was replaced in 1981 by a basket of five currencies — the US dollar, Deutsche Mark, French Franc, British pound, and Japanese yen.  After the euro was in place in January 1999, the SDR basket included only four currencies: the dollar, the euro, the pound and the yen. The SDR basket was expanded in 2016 to include the yuan as the fifth currency.

The euro is used by 19 out of 29 countries in Europe. It worked satisfactorily until the eleven countries that joined the euro zone in 1999 — Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain — kept their fiscal deficit within the parameters of the Maastricht Treaty (three per cent of their respective GDPs).

The problem started when countries like Greece were admitted into the euro zone on the basis of fudged budget figures. Due to problems in Greece, Portugal and Italy, the euro declined to $1.3384 on December 31, 2010. Currently, one euro is $1.13. It is just a question of time before a euro becomes equal to a dollar or even less.

In his article, “The Euro is still vulnerable: Can it survive?” in the Washington Post on January 6, 2019, Robert J Samuelson notes that while the euro has not achieved its central goal of increasing economic growth and strengthening public support for European political institutions, just the opposite has happened. The economic growth of all those countries that adopted the euro has lagged behind the US; in 2019, the euro zone’s projected growth is 1.6 per cent, compared to 2.6 per cent for the US.

Martin Feldstein, a professor at Harvard University, believes that the creation of the euro was an economic mistake. It was clear from the start that imposing a single monetary policy and a fixed exchange rate on a heterogeneous group of countries would lead to higher unemployment and persistent trade imbalances.

In the wake of the chaos that followed the June 2016 vote in favour of Brexit, The Economist noted in August 2018 that of 140-odd currencies tracked by Bloomberg, pound sterling depreciated against more than 120 currencies. The pound fell below $1.28 on August 10, 2018, its lowest level in a year. One expectation is that the pound may fall to $1.15, from its current level of $1.31, and to parity with the euro. Several economists agree that a no-deal Brexit will be disastrous for the pound sterling.

My submission in this paper is two-fold. First, since, of the five currencies in the SDR basket, both the euro and the pound sterling are in deep trouble, their continuance in the SDR is open to debate. The other two currencies, yen and yuan, do not enjoy a clean track record, since both Japan and China have manipulated their respective currencies in the past to boost exports. The rise of the yen from Y220 to a US dollar in 1985 to Y120 in 1986, when then US President Ronald Reagan imposed import quotas on Japanese cars, is a classic example. Had the IMF removed the yen from the SDR basket in its 1986 review, the yuan could not have made it to the SDR basket in 2016. As this leaves out only the dollar, the IMF should replace the outdated SDR with the US dollar.

Once the US dollar replaces the SDR as the single reserve currency, it could be thought of as a common currency for a select number of countries. Even after the introduction of the euro in 1999, the dollar accounts for nearly 64 per cent of global currency reserves, compared to 27 per cent held in euros, with 40-60 per cent of international financial transactions being denominated in dollars. If both the UK and the EU were to adopt the US dollar as their currency, it will lead to a substantial amount of savings in terms of conversion and transaction costs for payments to the Gulf countries for oil, which is priced in US dollars. 

Apart from the eleven countries that joined the euro zone in 1999 and Britain, the dollar zone could cover counties like Canada, Australia and Singapore, subject to certain criteria, like the Maastricht Treaty for the euro, to be prescribed by the IMF for admission into the dollar zone. US President Donald Trump could set the ball rolling for the US dollar to become a single reserve currency.    

The writer is a former Staff Member of the International Monetary Fund, Washington DC