More on the SDRs as a Reserve Currency

In my last post on the SDRs Rebecca Wilder questioned whether the SDRs will actually make a difference to the global economic imbalance problem. As a follow up to her question, I asked a friend who formerly worked at the IMF and the U.S. Department of Treasury his thoughts on the matter. Here is what he had to say (note that "Fund" is short for IMF):

This is a very long, tricky subject that I think starts with what is an SDR really? An SDR is basically a claim on another countries' reserves held via your account at the Fund. So when a country needs more USD it cashes in the SDRs at the Fund and the Fund tells the US Treasury to provide the USD. The country then runs a debit on its account at the Fund, which it pays interest, while the US gets interest on the "surplus" SDRs it has. The main point of these accounts is that some countries have hard currencies, while others (lets call them Argentina) have currencies from time to time that no one wants - so it's just a more complicated way of giving more countries access to currencies of other countries that are in demand at that time.

This doesn't really seem to me to be a workable currency yet - (1) it's not freely exchangeable in the market; (2) you can't just park reserves you accumulate in SDRs - if China has surplus USD, it can't simply go to the Fund and say I'd like to swap these for SDRs please; the IMF would have to fundamentally alter the way SDRs work to get to a system where the SDR could be usable as a reserve currency; (3) who controls the stock of SDR outstanding? When the Fund "creates" SDRs, all it is really doing is putting in place an agreement across its members to allow their currencies to be tapped by other Fund members when needed. The Fund can't grow the underlying SDRs out of thin air - every country would have to agree to put more of their currency on call. For the US , the Treasury Department would likely issue debt to raise the USD to give to a country that wants USD for its SDRs. Other countries might simply have their central banks print the money - but ultimately it's finite.

Beyond that, Rebecca's point is a decent one - if China is determined to keep its currency undervalued, then the real question is what currencies does it do so against. But that begs the question of why China would need SDRs in the first place; it could simply set an fx reserve accumulation policy of buying some USD, some EURO, some yen, and some GBP; I guess that would help the US by spreading some of china's capital outflows across more countries - and hence allow the USD to depreciate more relative to the CNY - since they would engineer a broader nominal effective depreciation.

If China's motive is more feeling the need for fx to insure against sudden capital outflows, then the Fund could help in theory. In practice it's hard since until the FCL the only way the Fund could deliver assistance was via programs which both had stigma and because they carried conditions meant that access to IMF resources wasn't automatic - so not a great way to insure yourself if you are a country; much better to have your own stockpile of USD.

A reformed SDR could play a role in this I think by being say a unit of account for parking reserves; but really the way the IMF could fulfill its function as insurer of last resort better is instead of telling a country to go run CA surpluses, accumulate a bunch of USD and bring them to us (and then what? does the Fund buy US Treasuries on China's behalf? that doesn't seem to solve any problems) is instead the Fund should act as a central clearinghouse for Central Bank fx swap lines. So when demand for a country's currency falls, it could go to the Fund and get more of the currency that demand has shifted into. Of course we go back to square one - is the country's currency falling because of unsustainable policies which require external adjustment - or is it just a temporary capital account fluctuation?

In short, the SDRs are not a panacea for the global imbalance problem.

Update: for a pro gold standard perspective on SDRs see here.