(Weekly Organ of the Communist Party of India (Marxist)
April 17, 2011
C P Chandrasekhar
NOBEL Laureate Joseph Stiglitz has written an article in the Financial Times dated April 1, 2011 arguing that a substantially enhanced issue of Special Drawing Rights (SDRs)by the IMF should be the first step in the reform of the international monetary system. The article is of special significance because it is based on a statement issued by 18 leading economists from across the globe calling themselves the Beijing Group, which includes nine known Chinese figures.
Few would object to the idea that the IMF
must further enhance the allocation of SDRs and alter its distribution
countries deal with situations of balance of payments stringency. But
difficult to believe that the issue of SDR’s would offer a solution to
problem that the
The Beijing Group advances three arguments in support of the SDR as an alternative reserve. The first is its view that it is because a national currency such as the dollar serves as reserve that the burden of adjustment to balance of payments imbalances falls on deficit countries, resulting in a global recessionary bias. Second, that the use of a national currency like the dollar as reserve forces the US to run unsustainable current account deficits to ensure that there is adequate global liquidity, and raises the danger that any effort of the US to shrink those deficits can generate global difficulties. And, third, that the dollar as reserve forces developing countries to accumulate large surpluses to “self-insure” themselves against future balance of payments crisis.
There are two difficulties associated with this line of reasoning. One is that the reading of the global economy and its functioning implicit in each of these arguments is questionable. The second is that even if the reasoning is correct it does not explain why the SDR is an alternative.
Implicit in the Beijing Group’s statement is the assumption that global problems arise solely or substantially because global outcomes result from the interaction of independent nation states. This underestimates the role of large corporations and finance capital. Once we take account of the motivations that drive corporations, especially the obvious one of maximising profits, an important determinant of the distribution of current account surpluses and deficits in a world of globally mobile capital and technology is the search of transnational firms for low cost production locations. Such locations normally tend to be a few countries with a large reserve of cheap labour. As a result the most productive, best-practice technologies get combined with cheap labour, raising the level of global surpluses and inducing an underconsumptionist, deflationary bias into the system. It is difficult to see how just the availability of more of any reserve would counteract this tendency.
The reserve accumulation in some countries
resulting from this process is compounded by flows of purely financial
encouraged by the accumulation of relatively cheap liquidity in the
financial system. That has resulted, inter
alia, from the
Created in 1969, the SDR was initially seen as a supplemental reserve which could help meet shortages of the two then prevailing reserve assets: gold and the dollar. The IMF issues credits of SDRs to its member nations, which can be exchanged for freely usable currencies when required. The value of the SDR was initially set to be equivalent to an amount in weight of gold (0.888671 grams) that was then also equivalent to one US dollar. After the collapse of the Bretton Woods system in 1973, however, the value of the SDR was reset relative to a weighted basket of currencies, which today consist of the euro, Japanese yen, pound sterling, and US dollar, and quoted in dollars calculated at the existing exchange rates. The liquidity of the SDR is ensured through voluntary trading arrangements under which members and one prescribed holder have volunteered to buy or sell SDRs within limits. Further, when required the Fund can activate its “designation mechanism”, under which members with strong external positions and reserves of freely usable currencies are requested to buy SDRs with those currencies from members facing balance of payments difficulties. This arrangement helps ensure the liquidity and the reserve asset character of the SDR. So long as a country’s holdings of SDRs equal its allocation, they are a costless and barren asset. However, whenever a member’s SDR holdings exceeds its allocation, it earns interest on the excess. On the other hand, if a country holds fewer SDRs than allocated to it, it pays interest on the shortfall. The SDR interest rate is also based on a weighted average of specified interest rates in the money markets of the SDR basket currencies.
The volume of SDRs available in the system is the result of mutually agreed allocations (determined by the need for supplementary reserves) to members in proportion to their quotas. Till recently the volume of SDRs available was small. Since then SDRs have been allocated on four occasions. An overwhelming proportion of the allocation has occurred in the aftermath of the 2008 financial crisis. But even now the quantum of these special reserves is well short of volumes demanded by developing countries.
Does the recent large increase in the amount of SDR’s allocated herald its emergence as an alternative to the dollar? There are two roles that the SDR can play, which favour its acceptance as a reserve. First, it can help reduce the exposure of countries to the dollar, the value of which has been declining in recent months because of the huge current account deficit of the US, its legacy of indebtedness and the large volume of dollars it is pumping into the system to finance its post-crisis stimulus package. Second, since its value is determined by a weighted basket of four major currencies, the command over goods and resources that its holder would have would be stable and even advantageous.
There are, however, five immediate and
obvious obstacles to the SDR serving as the sole or even principal
First, the $317 billion worth of SDRs currently available are
across countries and is a small proportion of the global reserve
estimated at $6.7 trillion at the end of 2008 and of the reserve
even a single country like
Third, since SDR issues are linked to quotas at the IMF and those quotas do not any more reflect the economic strength of members, the base distribution of SDRs is not in proportion to the distribution of reserve holdings across countries. Reaching SDRs to those who would like to hold them depends on the willingness of others to sell as noted earlier. Fourth, since the value of the SDR is linked to the value of four actual currencies, the reason why a country seeking to diversify its reserve should not hold those four currencies (in proportion to their weights in the SDR’s value) rather than the SDR itself is unclear. This would also give countries flexibility in terms of the proportion in which they hold these four currencies (which is an advantage in a world of fluctuating exchange rates, since weights in the SDR are reviewed only with a considerable lag, currently of five years). Finally, as of now SDRs can only be exchanged in transactions between central banks and not in transactions between the government and the private sector and therefore in purely private sector transactions. This depletes its currency-like nature in the real world. It also reduces the likelihood that a significant number of economic transactions would be denominated in SDRs.
Thus, the idea of a wholly new currency serving as a unit of account, a medium of exchange and a store of value at the international level does appear a bit far-fetched. The denomination of trade in that currency, the issue of financial assets denominated in that currency and the quantum and distribution across countries of the currency issued have to be all decided jointly and with consensus. That does appear near impossible as of now.