When the Special Drawing Right (SDR) was introduced in the late 1960s, the event was hailed as the birth of a new world currency. Since then, the infant has led a moribund existence. Only 21 billion SDRs have been issued in the last 40 years, around 0.3 per cent of current world reserves. But suddenly, the infant’s prospects look rosier. The G-20 meeting earlier this month gave its backing to creating $250 billion worth of SDRs, thus at a stroke increasing them to 4 per cent of world reserves. Even more important, the Governor of the Chinese central bank, Zhu Xiaochuan, in a well-publicised speech, advocated the replacement of the dollar by a “super-sovereign currency”, specifically the SDR.
The reason for China’s new-found interest in the SDR is obvious. The Chinese government is extremely worried that its massive foreign exchange reserves, which are mostly held in US treasuries, will lose value if the dollar depreciates. Towards the end of his speech, Zhu Xiaochuan gave an indication of what the Chinese would like: a new facility which would enable China to exchange its dollars for SDRs. The latter would be far more stable in value than the dollar since the SDR exchange rate is by construction an average of the exchange rates of the major convertible currencies. This raises the obvious question: who would take over the exchange risk that China wants to shed? This is precisely the issue on which, in the 1970s, attempts to establish a “substitution account” to convert dollar reserve holdings into SDRs broke down, the main protagonists then being the US and European countries. The Chinese are of course aware of this, which suggests that they are signalling a willingness to negotiate on the issue.
The rest of the world wants, or should want, two things from China: a) willingness to participate in exchange rate cooperation, and b) willingness to contribute extra resources to the IMF. As regards (a), it is clear that China’s unilateral dollar peg was a major factor underlying the huge current account imbalances which fed the wild credit boom in the US that led to the present crisis. Global stability requires that the key countries, including China, should agree on exchange rate arrangements that are different from the present ‘non-system’. As regards (b), China’s position as the world’s second-largest economy with a super-strong balance of payments indicates that its contribution to the IMF should increase. China, in turn, wants two things from the rest of the world. The first is a “substitution account”. The second is more votes in the IMF and hence greater influence in IMF decision-making. There is clearly a potential for a mutually satisfactory bargain.
A “substitution account” would increase sharply the quantity of SDRs in official circulation. If this were combined with regular creation of SDRs and measures to make it possible for the private sector to hold SDRs, world economic stability would be materially improved for the following reasons. Firstly, a “substitution account” would help not only China but also other countries to diversify their foreign reserves. Secondly, a substitution account would help to prevent crises which may be caused by large switches between major reserve currencies. Thirdly regular issues of SDRs would reduce the need for developing countries to acquire reserves by running current account surpluses. Some countries (such as China!) have found it advantageous to do so in order to enjoy export-led growth, despite the implied reduction in their domestic spending. But as recent experience has confirmed, this strategy is internationally harmful if practised by one or more significant countries. Fourthly, many less developed countries acquire reserves not by earning them but by borrowing on the world capital market. Since the spread between the borrowing rate and the deposit rate (the US treasury bill rate) obtained on the reserves is large, holding borrowed reserves leads, in effect, to ‘reverse aid’ to the advanced countries. Moreover, these reserves tend to disappear when they are most needed, since the underlying loans are hard to roll over in a crisis.
Of course, if the SDR is successfully promoted, the main reserve issuers, viz the US and, to a lesser extent, the eurozone, will be unable to retain the ‘exorbitant privilege’ of obtaining real resources from the rest of the world by printing money. But they too, along with other countries, would share in many of the benefits outlined above. In sum, the world as a whole has much to gain and little to lose by a comprehensive agreement in which the role of the SDR is enhanced and the key countries, including China, adopt an agreed exchange rate system. The prospects of the SDR were bound to be dismal while the US was the sole hyper-power. But as we move into a genuinely multi-polar world, the SDR’s time may finally have come. The G-20 must seize the opportunity to reform the global monetary system, once the present crisis has abated. Any such reform would be deficient without a more prominent role for the SDR.
The author is a Fellow of St John’s College, Oxford and an Emeritus Fellow of Merton College, Oxford
