Monday, December 8, 2014

IMF Reforms and SDR's - Why Should Anyone Care about Them?

One of our missions here on this blog is to try and encourage the average person who would not normally curl up next to the fireplace to read an IMF workpaper to learn more about how major monetary system change might impact their daily life. It's only natural for such a person to ask the question in the headline above for this blog post. Why Should I Care about what the IMF does? Let's explore that.

Since we get a lot of new readers here every week, let's start with some even more basic questions:

What is an SDR?    What IMF reforms are you talking about?    How would either of these ever have any impact on my daily life?  All good questions. Let's answer these first and then try to look at why you should care about what  the answers mean to you.

What is an SDR? - The SDR is a unit of account used at the IMF like a form of currency. We can just let the IMF answer the question directly right here. Here is their summary explanation word for word:

"The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28, 2009 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to around SDR 204 billion (equivalent to about $309 billion, converted using the rate of September 4, 2014)."

Let's just think of SDR's as money that the member nations of the IMF can exchange between themselves, but is not available right now for use in general commerce or by the public at large. Nations can borrow and lend them to each other. The nations can exchange them for actual national currencies. The IMF keeps track of who owns what in terms of SDR's. China would like to see its yuan added to the SDR currency basket in 2015. The current SDR basket includes the US dollar, British pound, the Euro, and the Yen.

What IMF reforms are you talking about? - In 2010, a majority of IMF member nations approved a change in the quotas (share of SDR's and voting power) that would increase the influence of the emerging nations (like China and the BRICS) within the IMF. The IMF explains it in detail here. And an important note is that under the reforms the amount of SDR's in total would double as explained here:

"Member countries’ quotas, the IMF’s principal source of financial resources, will double under the 14th General Review of Quotas to SDR 476.8 billion (about $755.7 billion at current exchange rates) from SDR 238.4 billion agreed under the 2008 quota and voice reform."

For these reforms to pass and become effective, more than 85% must vote in favor as stated here:

"The Board of Governors, the IMF’s highest decision-making body, must ratify the new agreement by an 85 percent majority of votes cast before it comes into effect."

Since the US currently has a 17% vote, it essentially has veto power. The US Congress has not approved the 2010 reforms. Until they do, the SDR quotas will not change (giving more influence to the BRIC nations). Congress also is holding up approval of a US infusion of $100 billion to the IMF (this is complicated but you can get the details here).

How might this impact my daily life? - This is the important question. First, you should know that there is a serious movement around the world to have the SDR unit eventually become a global reserve currency. Here is a pdf of a paper written back in 2009 by Dr. Zhou Xiaochuan, a Governor of the People's Bank of China. This was written after the big global financial crisis of 2008 (an event that impacted a lot people's daily lives). This paper is a plea to replace the US dollar over time with the SDR as the global reserve currency. Please click on the link above and read the document. It's not that long. There are four main points which I will list below:

1- The outbreak of the (2008) crisis and its spillover to the entire world reflect the
inherent vulnerabilities and systemic risks in the existing international monetary system.

2- The desirable goal of reforming the international monetary system, therefore,
is to create an international reserve currency that is disconnected from
individual nations and is able to remain stable in the long run, thus removing
the inherent deficiencies caused by using credit-based national currencies

3- The reform should be guided by a grand vision and begin with specific
deliverables. It should be a gradual process that yields win-win results for all.

4- Entrusting part of the member countries’ reserve to the centralized
management of the IMF will not only enhance the international community’s
ability to address the crisis and maintain the stability of the international
monetary and financial system, but also significantly strengthen the role of
the SDR.

Notice that the whole basis for the proposed change to the monetary system in this article is to allow the IMF to take responsibility for responding to crisis and be the entity that provides stability. This is why watching to see what happens with the 2010 IMF reforms matters. While the 2010 reforms don't seem all that significant right now, they are a signal that the IMF will take over the next time the world faces a crisis. Doubling the quota of SDR's would be a key first step in that process to show that the IMF could step in as a global lender of last resort. Also notice that this paper says they need to move away from "credit based national currencies". A question you may wish to ponder is what would NOT be a credit based currency (like the US dollar Federal Reserve notes are). An asset backed currency?

If this does eventually happen, it can certainly impact your daily life. The strength of the US dollar, in spite of all the QE and stimulus programs that have vastly expanded the supply of US dollars, is that it is still the world's reserve currency. Losing that status will most likely involve a significant loss of its purchasing power during the transition process. And everyone in the US would be impacted because everyone mostly owns assets tied to the US dollar. It's why everyone needs to have a plan in mind in case the US dollar does suffer a significant loss in purchasing power (either very rapidly in a crisis or over a few years as a more controlled transition unfolds).

This, in a nutshell, is why everyone should care about SDR's and IMF reforms. They would increase the power and influence of the IMF as a lender of last resort. Someday you may be using a calculator to figure out the exchange rate between your local national currency and SDR's. 

An interesting side story to this potential coming change is if the SDR currency unit could somehow be tied to an external (outside the IMF) global reserve currency that everyone (including the general public) could own and use. This is something we have covered here and is possible. The IMF charter does not allow the public to own SDR's, but what if there was a digital asset backed reserve currency the public could own with the same system backing as the SDR someday? Food for future thought in the years to come.

Here is an opinion article that states the case for opposing the IMF reforms. It notes that the current lame duck session of Congress might consider passing them which is something we will watch for here.

In the meantime, if you see news about SDR's and IMF reforms, you should probably pay attention and you definitely should care about it. Of course we will cover it here to see what happens. Tomorrow we take a deeper look at the effort to get the Yuan in the SDR basket.

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