With more news coming lately about SDRs, I am realizing that for most people this can quickly become a very confusing topic. It's understandable. First, most people probably have never even heard of an SDR. No regular citizen anywhere can use SDRs to buy anything like they would their own currency (US dollars, Euros, Yen, etc). Secondly, many people tend to say: Why Should I Care about an SDR?
I don't know if people need to care about them any time soon or not. However, lately there is a lot of SDR news that people who do follow these things feel is significant. We have the World Bank press release about its coming issuance of "SDR Denominated Bonds". We have the IMF releasing news in July that they are planning to do a study on the potential for broader use of the SDR in the global monetary system (July 2016). We have the G20 saying they support broader use of the SDR (see item #8) and look forward to the IMF report due out by January 2017. So, something is clearly up related to the SDR.
I thought perhaps it might be helpful to people totally unfamiliar with SDRs to try and provide at least some very basic information on them. I believe this to be a very large group of people. Below is a series of Q&A's to try and do that. Hopefully, they will be helpful to anyone wanting to learn more and not add to the confusion :-)
------------------------------------------------------------------------------------------------------------Q: What are SDRs?
A: Do you mean official reserve SDR's used within the IMF system of member nations only or the private version of SDRs the IMF is now calling M-SDRs?
Q: Excuse me. You mean there are TWO kinds of SDRs? One is hard enough to follow.
A: Yes, the IMF describes the official reserve SDRs here on their web site as follows:
"The Special Drawing Right (SDR) is an interest-bearing international reserve asset created by the IMF in 1969 to supplement other reserve assets of member countries.
• The SDR is based on a basket of international currencies comprising the U.S. dollar, Japanese yen, euro and pound sterling(and the yuan starting in October 2016). It is not a currency, nor a claim on the IMF, but is potentially a claim on freely usable currencies of IMF members. The value of the SDR is not directly determined by supply and demand in the market, but is set daily by the IMF on the basis of market exchange rates between the currencies included in the SDR basket.
• It can be held and used by member countries, the IMF, and certain designated official entities called "prescribed holders"—but it can not be held, for example, by private entities or individuals. Its status as a reserve asset derives from the commitments of members to hold, accept, and honor obligations denominated in SDR. The SDR also serves as the unit of account of the IMF and some other international organizations."
This July however, the IMF explained to us that there is another version of the SDR other than these official reserve SDRs. In their recent statement, they explain the difference here:
"This note sets out some initial considerations on this matter. The note sketches some key issues bearing on the role of the SDR . . . (i) the official SDR, or “O-SDR”, the composite reserve asset issued and administered by the IMF; (ii) SDR-denominated financial market instruments, or “M-SDRs,” which could be both issued and held by any parties."
Q: I am a little confused. Why are there two kinds of SDRs and what is the biggest difference?
A: It does get a little confusing. One key difference is who can "issue and hold" each version. Only the IMF can issue the official reserve SDRs and relatively few entities (mostly IMF member nations) can hold them. M-SDRs are different because they "could be both issued and held by any parties." Short version for those of us who are not IMF members: We cannot own or try to use (spend) any of the official SDRs, but it is possible that we could own assets denominated in M-SDRs (like bonds for example).
Q: What do you mean "assets denominated in M-SDRs?
A: This is an asset that derives its value based on the basket of currencies used to value the official reserve SDR (the US dollar, the Euro, the Yen, the Pound, and soon the Chinese Renminbi). Using an SDR denominated bond as an example, the value of the bond from a currency standpoint would actually fluctuate daily based on the floating exchange rates of the five currencies used to make up the SDR currency basket.
Q: So, Can I cash in such a bond and go spend my "M-SDRs" anywhere?
A: As far as I know, there is no place on earth you or I could spend an M-SDR like we would US dollars or Euros, etc. There are no M-SDR bills (like say a $10 bill in your billfold or purse) that exist.
Q: This is getting a bit confusing again. If I can own these 'M-SDRs" but cannot spend them anywhere on earth, why would I want any of them?
A: That's a good question right now. The only way you could convert them into something you could actually spend would be to exchange them (at the current currency exchange rates) into a currency of your choice that is a legal tender currency.
Q: OK, so again, Why would I want any of these?
A: Right now for most people there is probably not a compelling reason to own them. If you were wanting to hedge your own national currency for some reason (you felt it might go down in purchasing power for some reason) you might use this M-SDR asset to do that since it is valued based on a composite of the five currencies in the SDR currency basket. But honestly, you could also do that by just obtaining the five currencies in the same ratio they are used in the SDR basket to do the same thing. Right now, that may be easier than trying to use an SDR denominated bond to do that and almost certainly less confusing to most people who have never heard of any kind of SDR.
Q: OK, if all this is correct, explain to me again: Why I should care about all this or even want to fool with SDRs?
A: I'll try. Many people believe that the current monetary system we use now has problems. It relies heavily on the US dollar. This can get complicated quickly, but this over reliance on the US dollar along with other problems like too much overall debt etc. are creating stress on the system we use now. Many people believe at some point in the future the stress might become so great it causes the system we use now to stop functioning properly (or even at all). If this were to happen, all kinds of consequences might follow that impact things like what the US dollar is worth (and also all other currencies). Some think a "reset" of the system might be needed under those circumstances. Some also think the SDR might then take a more prominent role in the monetary system and somewhat replace the US dollar. If that happens, then we all care quite a bit about SDRs and if we should be trying to own them or something else like gold for example (what will we trust?). No one can know the future, but there are many who follow all this closely and think it is possible the current system will have to be replaced. Some sooner than others. This blog watches for all that. (added note 8-19-16: here is a very creative video that kind of summarizes the above in less than 8 minutes based on the view of Jim Rickards)
Q: So, when I see headlines in the news saying "SDR to replace the US dollar", which version of the SDR are they talking about?
A: Now you've got me. I honestly don't many times myself. Sometimes I am not sure if the author of the article even realizes two versions exist. We now enter the realm of the unknown and all we can do is ask more questions that do not currently have answers as far as I know like:
- Would everyone be allowed to own SDRs in the future?
- If so, which version? or would they change things so only one universal version was used?
- How would any future SDR I could own connect with my national currency?
- How would any future SDR like this be anchored (or backed)?
- Would a conversion to some kind of SDR happen quickly or slowly?
- Would the public even accept any kind of new SDR (or any other proposed global currency)? Also, if not would everyone start trying to buy gold?
We could keep this up, but I suspect these are enough unknowns.
Q: Thank you for trying to help, but I am still a bit confused on how all this might work. Any more you can add?
A: Not right now. I feel your pain. I can only refer you to the title of this article and say I understand why you may not feel all is perfectly clear. It's because it is not. I have been following this for over two years and it is all I can do to try and keep it straight.
This article is the first of three to be published with some basic information on the SDR. For more in depth information, go to our page of archived articles here.
Added note: I have this bit of followup news from Willem Middelkoop. He sent me an email with permission to publish this quote:
"So Dr. Coats, Jim Rickards and myself all agree on the time line of the SDR process.
But the real shocker will be once investors start to realise dollar assets can be exchanged for SDRs in a not too distant future."
But the real shocker will be once investors start to realise dollar assets can be exchanged for SDRs in a not too distant future."
Just to make sure, I asked him if he was talking about the private SDR (M-SDR) or the official SDR in this quote. He replied with this answer:
"exchange fund is for official SDR's initially"
Later, I got this added bit of information from Willem to say that he is not trying to make a prediction on the timing for a large swap of official SDRs for US dollars:
"Again, I cant prove this will be possible soon, but such an (account/fund) exchange mechanism is the only possible solution to restructure $-debts (other debts possible could be restructured through this as well)"
I believe he is talking about the substitution fund he wrote about in his recent article that we covered here. This would be significant news related to the SDR whenever it did take place. I am advised by Dr. Warren Coats that:
"The only limit on the number of SDRs that could be created via a substitution account is the amount of reserves central banks have to exchange for them."
I should add that it is my understanding from Dr. Coats that in order for the IMF to create this kind of substitution fund, they would need 85% approval from members which means the US would have be in agreement since it holds a 16% vote. All this just provides even more incentive to watch for any news related to this type of exchange fund at IMF. It would signal a breakthrough in the potential expansion of SDRs and that the members can reach consensus on such an important issue. In that regard, please note Dr. Coats comment below on how they have been unable to do this in the past on this issue.
Also, here is a new article in The Epoch Times by Valentin Schmid that fits well with this blog post as it talks about some of the issues we covered in the Q&A above and the new SDR Bond issue. It also quotes Jim Rickards and Willem Middelkoop. It does a good job of making the distinction between the official SDR and the M-SDR (private SDR). And I do understand if you are still a little confused.
Additional added note: After reading the information from Willem about the concept of a substitution fund, Dr. Warren Coats sent me this as a bit of interesting history related to this idea from the past. This is interesting information we just cannot get anywhere else and I appreciate so much he shares it with us:
"To add to my note a few minute ago, the IMF failed to adopt the substitution account in the 1970s because the membership could not agree on how the liability from exchange losses that might be incurred from issuing SDR liabilities against dollar asset should be allocated. The US wanted any losses to be born in proportion to quotas and the rest of the membership want any dollar losses to fall on the US." --- Warren Coats
"The only limit on the number of SDRs that could be created via a substitution account is the amount of reserves central banks have to exchange for them."
I should add that it is my understanding from Dr. Coats that in order for the IMF to create this kind of substitution fund, they would need 85% approval from members which means the US would have be in agreement since it holds a 16% vote. All this just provides even more incentive to watch for any news related to this type of exchange fund at IMF. It would signal a breakthrough in the potential expansion of SDRs and that the members can reach consensus on such an important issue. In that regard, please note Dr. Coats comment below on how they have been unable to do this in the past on this issue.
Also, here is a new article in The Epoch Times by Valentin Schmid that fits well with this blog post as it talks about some of the issues we covered in the Q&A above and the new SDR Bond issue. It also quotes Jim Rickards and Willem Middelkoop. It does a good job of making the distinction between the official SDR and the M-SDR (private SDR). And I do understand if you are still a little confused.
Additional added note: After reading the information from Willem about the concept of a substitution fund, Dr. Warren Coats sent me this as a bit of interesting history related to this idea from the past. This is interesting information we just cannot get anywhere else and I appreciate so much he shares it with us:
"To add to my note a few minute ago, the IMF failed to adopt the substitution account in the 1970s because the membership could not agree on how the liability from exchange losses that might be incurred from issuing SDR liabilities against dollar asset should be allocated. The US wanted any losses to be born in proportion to quotas and the rest of the membership want any dollar losses to fall on the US." --- Warren Coats
Why should we allow an unrepresented organisation to print money for sovereign nations?
ReplyDeleteThank you for the comment. This is a good question that I see many people ask. If this is ever proposed it will be interesting to see how the public reacts because national sovereignty is certainly one of the key issues involved. We can add that to our list of unknowns right now.
ReplyDelete