Monday, January 18, 2016

Diving Deeper into Dr. Warren Coats Real SDR Proposal

Our recent blog article with emails from Dr. Warren Coats explaining his Real SDR proposal was extremely popular. It instantly moved near the top of the list for most page views here. When I was reviewing the article I happened to click on this link Dr. Coats sent in his email. It is a pdf version of the most recently updated version of his proposal. Only then did I realize this new version was even more detailed and interesting than the only one I had seen before (dated 2011).

After reading this new updated version I felt another blog article that looks at this latest updated version more in depth was needed. I would highly encourage all readers to download the full pdf version and read it. Below I have selected some of the key points and quotes in it to just illustrate how worthwhile this material is for those of us interested in this topic. Please read the full article here to get proper context.

"The unilateral closing of the gold window by the United States in 1971 brought the world into a costly and trade inhibiting era of floating and unpredictable exchange rates. However, the current dollar standard suffers from several deficiencies beyond exchange rate chaos. The well known Triffin dilemma—that as the trade deficit of the supplier of the international reserve currency grows to meet the world’s demand for it, confidence in the currency at some point weakens—only gets more worrisome for the dollar with time, not for the reasons Triffin suggested but because of political/fiscal weaknesses within the U.S. In addition, the Federal Reserve has never given much attention to the impact of its monetary policy decisions on international holders and users of its currency. And the U.S. is increasingly using its control over most international payments to impose its political will (FATCA, payment sanctions, etc.), not always shared by others, on the rest of the world."

. . . . .

According to James Rickards, in “The Death of Money: The Coming Collapse of the International Monetary System”7 the willingness of China and other central banks holding over 8 trillion U.S. dollars in their foreign exchange reserves to continue doing so will collapse sometime in the next decade. When it does, he says, this time the dollar’s reign as the world’s reserve currency will end. Eswar Prasad, on the other hand, argues that the dollar will hang on for lack of a decent alternative. Rickards predicts that only a massive allocation of SDRs will save the system and reestablish a new one."

. . . . .

"In this paper I offer suggestions for the issues involved in implementing this Real SDR reform and thus a first draft of an implementation plan. Implementation is divided into two stages. The first stage establishes the SDR as “the principal reserve asset in the international monetary system” in fact rather than just on paper. The second stage replaces national currencies (or at least many of them) with SDRs directly or once removed via fixed exchange rates, thus returning the International Monetary System to a single (or dominant) currency in the spirit of the gold standard."

Note: Below are the steps (headlines only) listed by Dr. Coats to implement his proposal:

Stage One: International Reserve Currency

1. The international community should agree on amendments to the IMF’s Articles of Agreement to authorize and require it to issue SDRs under currency board rules. 

2. The above amendments should commit IMF members to exchange their existing foreign exchange reserves for SDRs (i.e. to buy SDRs from the IMF)

3. The IMF should move more vigorously to promote adoption of the SDR for invoicing globally traded commodities such as oil, copper, gold, etc. and should encourage international banks to develop financial instruments denominated in SDRs.

Stage Two: National Currencies – Single Global Currency

1. The transition: What might the transition look like from the current situation to the fully implemented system described above? Several issues would need to be addressed . . . 

2. The balance of payments - With national currencies fixed to the real SDR, the issue of maintaining a balance of international payments remains as critical as under any other system of international payments. . . . .

3. Banks and the Chicago Plan - The primary motivation for creating central banks historically (aside from their convenience for clearing and settling payments between banks and for issuing currency) arose to provide a lender of last resort to banks experiencing deposit drains. . . .  .


Replacing the U.S. dollar as the principle international reserve currency and the wide spread floating of exchange rates with a real SDR issued under currency board rules has a number of important advantages: a) IMF issued SDRs would not be a claim on the U.S. or any single national (or regional) issuer; b) the supply would always match the market’s demand (if issued under currency board rules); c) the real value of the international invoicing and settlement asset would be stable for the foreseeable future (if the SDR valuation basket is based on real goods and commodities); and d) the costs of exchanging currencies and hedging exchange rate risks would be reduced.

The improved efficiency and reduced risks of global trade would further increase such trade, which would benefit all countries including the United States. Countries that fixed the exchange rate of their currency to the real SDR would not surrender monetary policy to another country or an international central bank as the supply of SDRs would be determined by market demand. The U.S. would lose the seigniorage it now enjoys to the extent its banknotes are held abroad but would still enjoy the competitive advantage of its financial sector in supplying the world with efficient, liquid and credit worthy financial instruments. The U.S. would no longer need to shift its manufacturing off shore to generate its BOP (balance of payments) needed to supply its currency abroad.

 The U.S. would lose the political leverage it now enjoys as a result of the critical importance of the dollar in international payments, but its heavy handed use of that leverage is likely to weaken the dominance of the dollar over time anyway. Similarly, the failure of the U.S. government to rein in its unfunded fiscal liabilities and associated future deficits and keep interest rates and inflation under control is likely to lead other countries to abandon the dollar whether the U.S. agrees to the change or not

Replacing the U.S. dollar as the world reserve currency with a real SDR is the critical first step to a reformed system. The coming collapse of the dollar predicted by Rickards and the real SDR currency board discussed here provide the “major shock to the dollar and [the] viable alternative to dislodge it” that are needed to push the world into a true reform of the international money system.
The above list from Dr. Coats article are just the headlines for the key points in his proposal. It is necessary to read the full article to understand the proposal properly. If you have any interest in this topic, this proposal is a MUST READ.

My added comments: There you have it. Confirmation of all that we have been covering and talking about on this blog now for two years from the former head of the IMF SDR Division. It almost feels like my work is done here :)

Please note that Dr. Coats points out that another major global financial crisis as predicted by Jim Rickards would "provide the major shock to the dollar and the viable alternative to dislodge it that are needed to push the world into a true reform of the international money system." The is exactly what we have been saying here on this blog. Change tends to move slowly unless a crisis arises that motivates major change more quickly. I will add that until this week I had no idea that Dr. Coats had referenced Jim Rickards' thoughts on the SDR in his proposal. This was something new that was not in the earlier version I had seen from 2011.

Obviously we don't know if we will get another major crisis any time soon and we also don't know if the public would embrace a new SDR based system like Dr. Coats proposes or not. It's certainly possible that if a fiat US dollar based system fails, the public might reject another fiat based system of any kind. If that happens, we might see some kind of asset backing return to the currency.If we do get another crisis, it is reasonable to assume that a system like Dr. Coats describes could be offered as a solution to the crisis. As I read his proposal, it could possibly be tweaked to add an asset backing component if needed to restore public confidence. Therefore, understanding how it would work is valuable regardless of what does happen in the future.

Getting a better understanding of how something works is always worthwhile and Dr. Coats writes in a style that makes that possible for the average person like myself. I have discovered another interesting article by Dr. Coats that I hope to cover here in the future. It talks about how to tie the SDRs' value to a basket of commodities instead of a currency basket like it is now. His ideas are interesting and very much worth the time and effort to read for anyone who wants to learn more about these issues. My view is that we should all have interest in these issues and we owe thanks to those who share their expertise and understanding on these complex topics with the public.

Added note: Jim Rickards tweet on this is here. 



  1. Thank you for your post on Coats. It is a breath of fresh air to possibly see some semblance of common sense enter this fiat currency fiasco an perhaps move away from Keynesian theory BS

  2. You are welcome. Dr. Coats is a true expert and has interesting ideas. An exclusive interview with him will appear on the blog here Saturday (Jan 23rd) which you may enjoy. He has also pointed me to his writings which I will feature on the blog in the future.