Monday, August 3, 2015

Roadblocks to the SDR Becoming a Global Currency

One of the two big questions we are following here is if the SDR used at the IMF will eventually become a global currency that everyone can use. There has been a lot of buzz about this question ever since a 2009 article by PBOC Governor Zhou Xiaochuan calling for the SDR to become a global reserve currency. It's now six years later with nothing in sight to indicate the SDR will become such a thing. Clearly this kind of change moves very slowly. Let's take a look at some of the reasons why.

This 2010 article in The Federalist Debate can serve as a useful guide for us in answering this question. It was written by Elena Flor of the Intesa Sanpaolo Group from Italy. This article was calling for the world to move forward on the Chinese proposal to make the SDR a global reserve currency. It listed several steps that would have to take place for this to ever happen. This is a long and detailed article, so below we will list those steps with a brief summary for each one. It will serve us well in looking at the roadblocks to the SDR becoming a global currency.


"What has to be done to effectively use the SDR as a supra-national reserve currency? Which problems remain to be solved?"

1. The composition of the basket of the SDR 

A most important step for the SDR to become a global currency is to determine what the proper composition of the SDR basket of currencies shoud be. This is always a subject of great debate and change takes place very slowly. This fall we find out if the Chinese Yuan (and perhaps other currencies) get added in. Until this is resolved on a more permanent basis, it remains a roadblock to use of the SDR as a global currency. (update 8-8-15: IMF delays decision on adding the yuan into the SDR basket - clear example of how things move slowly) (update 11-30-2015 - the IMF approved inclusion of the Yuan into the SDR currency basket to be implemented in the fall of 2016)

2. Reform of the IMF 

"After years of neglect, the IMF has recently received international support for a revived activity. In line with this idea various suggestions have been put forward in order to strengthen its activities. Also to support the market of the SDRs, a reform of the IMF is needed. This reform would involve the activities to be carried out by the IMF, the funds at its disposal (currently inadequate), governance both in terms of governing bodies and majorities required for its activities to be carried out and of quotas and representation." 

my added comment:

Here we are in 2015 and the proposed 2010 reforms remain in limbo. This speaks volumes about the pace of change and remains another roadblock for the SDR. (update 12-22-2015 - the US Congress approved the 2010 IMF reforms doubling the number of SDR's and giving more voting power to emerging nations)

3. Change and increase in SDR allocations 

There aren't near enough SDR's available for it to be used as a global currency now. There is nothing right now that would suggest a big increase in SDR's is on the horizon. Unless that changes it remains a big roadblock to the SDR. What could speed up the process? A crisis.

4. Issue of SDR denominated securities (Bonds) *** This is a big one

"The issue of SDR denominated securities would be a good starting point to increase the appeal of the SDRs. One can make the hypothesis that initially the IMF itself, some Governments and special international financial institutions such as the World Bank could issue SDR denominated securities, which could then be followed by banks and non-financial firms."

"Among the Governments, the US could provide a good example for other countries: if it agrees that a shift towards a more stable and globally balanced international monetary system is desirable it could issue part of its bonds not only in US dollars but also denominated in SDRs."

The importance of such a step would constitute a good example to be followed by other countries. However, considering the current US resistance to these proposals, it is unlikely that the US opens the market for SDR-denominated securities. The remarks made by the Governor of the People’s Bank of China are supportive of a market for the SDR denominated assets. It has been suggested that therefore they (China) could issue SDR denominated bonds and encourage other G-20 members to follow their example. This would be important because it would foster market liquidity for SDR denominated securities, and it would be more important than buying IMF SDR denominated bonds – which they are already doing – since the IMF bonds cannot be traded according to current rules." 

my added comment:

The article calls for a broad SDR bond market that moves into the private sector. But the article also notes that "considering the current US resistance to these proposals, it is unlikely that the US opens the market for SDR-denominated securities". It then suggests maybe China could give SDR bonds a try. Right now, nothing like this is being proposed so this remains a huge roadblock to the SDR becoming a global currency. But we should keep an eye out to see if the new BRICS Bank (NDB) or the AIIB issue any SDR based bonds. For that matter we should watch to see if anyone anywhere issues any SDR based bonds. (update 1-21-2016 - former IMF head of SDR Division and Chinese co-author Dongsheng Di call for the AIIB to issue SDR bonds

5. The set-up of a clearing system 

"The experience with the ecu has clearly shown that the setting up of a clearing system is a crucial point. The establishment of a clearing system for the ecu facilitated its use and the growth of the market, proving to be the best way to build up liquidity. The Bank for International Settlements was called to act as clearing house. Similarly, but considering the different nature of the market of SDRs (public rather than private), it can be said that the setting up of a clearing system for central banks investing in SDRs would constitute a step of great importance."

my added comment:

The article points out that a central global clearinghouse for SDR bonds and securities would be essential. The IMF and/or BIS come to mind for this. Nothing like this exists today, so this is another roadblock for the SDR to overcome.


This article does a great job of listing the big roadblocks to the SDR becoming a true global currency (let alone a global currency that everyone could use). If all these huge changes have to take place at the existing pace of change, it could easily be well past my lifetime (I'm 59 years old) before the SDR becomes a global currency. Just look at all the problems and delays just trying to get the relatively minor 2010 IMF reforms approved for example.

This is why we note here on the blog that for this kind of change to happen rapidly, there will almost certainly have to be a huge global financial crisis that motivates people to accept major changes more quickly. Changes that would otherwise take years to decades to unfold. Jim Rickards and others are predicting this very thing to happen sometime in the coming months or years (certainly within my expected lifetime). 

This is why we have selected two big questions to follow here on the blog:

1) Will we get another big global financial crisis worse than 2008 as Jim Rickards and others are predicting?

2) Will the SDR used at the IMF eventually become a global currency that everyone can use?

The two questions are connected in that if we get a yes answer to question #1, it could lead much more quickly to a yes answer to question #2. 

If we get a no answer to question #1, the path to SDR use as a global currency probably gets longer and tougher due to all the roadblocks listed above. But it could still happen over a longer time frame. The technology for it to happen already exists today so that is not a roadblock.

We also need to see if the BRICS group is eventually going to be in or out regarding the SDR. For now they are clearly in. But at some point they could decide to go it on their own if nothing changes at the IMF. If they eventually exit the IMF, the SDR is unlikely to become a truly global currency (if more than half the world is not using it).  An exit by the BRICS looks very unlikely right now.

A reader may ask, Why should I care about all this and how will it impact me? 

If the answer is no to both questions above, you probably don't need to care. If the answer to question #1 is no and to question #2 is yes, but over many years, you may not need to care any time soon.

However, if the answer to question #1 is yesit is obvious that another major global crisis worse than 2008 will directly impact all of us. Stocks, bonds, pension funds, annuities and currencies will all get hit. Safety net programs could be lost. Lots of jobs will disappear. Governments could fall. There could be civil unrest on a global scale. That much is pretty easy to see.

But even if there is no such crisis, if the SDR rises to become a global reserve currency for any reason, the value of the national currency you use could certainly be impacted. Many believe the US dollar would take a substantial devaluation in the process for example. This is why you should care about all this and how it might impact you directly some day. It's why we are following these two big questions here.

Added note (8-4-15): Reuters reports IMF will delay inclusion of the Yuan into the SDR until September 2016. This is what we mean when we say this is a slow process. 

Update: (1-25-2016):  with the inclusion of the Yuan in the SDR currency basket, passage of the 2010 IMF reforms, and the call by former IMF official Warren Coats for the AIIB to issue SDR bonds, a number steps forward have been taken that could lead to broader SDR adoption in the future.

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