Sunday, October 1, 2017

Dr. Warren Coats (former IMF) Comments on Proposal to Issue SDRs to "Finance Development"

I routinely search for news related to the SDR issued at the IMF since some believe that the SDR could be offered some day as a replacement to the US dollar as a global reserve currency. We have covered the SDR in depth here and have been fortunate to get direct input from one of the leading experts in the world on the SDR (Dr. Warren Coats). 

I ran across this article in which is written by Anis Chowdhury and Jomo Kwame Sundaram. The article says that there is a UN proposal to revive "the idea of the IMF issuing Special Drawing Rights (SDRs) to finance development." Since some have talked about the IMF issuing the SDR in ways like this in the future, this article caught my attention. 

Below are a few excerpts from the article and then further below some comments by Dr. Warren Coats he provided with permission to publish here after he reviewed it.  (bold emphasis below is mine)


"The Business and Sustainable Development Commission has estimated that achievement of Agenda 2030 for the Sustainable Development Goals will require US$2-3 trillion of additional investments annually compared to current world income of around US$115 trillion. This is a conservative estimate; annual investments of up to US$2 trillion yearly will be needed to have a chance of keeping temperature rise below 1.5°C.

The greatest challenge, especially for developing countries, is to mobilize needed investments which may not be profitable. The United Nations and others have revived the idea of the International Monetary Fund (IMF) issuing Special Drawing Rights (SDRs) to finance development."

. . . . .

"Despite some reforms over the decades, IMF quotas are biased in favour of rich countries. Thus, arguably, SDR distribution based on IMF quotas is not neutral. Allocating more rights to provide poor countries with development finance would help redress this bias.

The UN has long argued for creating new reserve assets (i.e., SDRs) to augment development finance instead of current provisions for distribution according to IMF quotas."

. . . . .

"However, the proposal was blocked by the Group of Ten developed countries. They argued that the proposal, for permanent transfers of real resources from developed to developing countries, would contradict the original intent of costless reserve creation. Additionally, the G10 argued, direct spending of SDRs would be inflationary."

. . . . 

"Another recent UN proposal could help overcome resistance to issuing SDRs for development finance. The proposal involves floating bonds backed by SDRs, not directly spending SDRs. Arguably, leveraging SDRs thus would expose bond holders to illiquidity risks and distort the purpose (i.e., reserve asset) for which SDRs were first created.

Opposition to the proposal should be reduced by only leveraging 'idle' SDRs held by reserve-rich countries to purchase such bonds. This would be comparable to countries investing foreign currency reserves through sovereign wealth funds, where the liquidity and risk characteristics of specific assets in the fund determine whether they qualify as reserve holdings. Thus, careful design for leveraging SDRs, while maintaining their reserve function, can mitigate objections."

. . . .

Dr. Warren Coats is the former head of the SDR Division at the IMF (1983) and has written extensively about it including his own proposal to use the SDR as a reserve currency based on Currency Board rules for issuance and backing it with a basket of goods and services. 

After reviewing the article mentioned above, he provided these comments with permission to publish them here. This kind of expert input is invaluable because it helps educate us and reduce the confusion that I see so often when the SDR is discussed. Here are Dr. Coats comments:

"Allocating SDRs to finance development, when first proposed in the 1970s, permanently tarnished the image of an internationally supplied reserve asset. The biggest worry of the public when giving the authority to a central bank or anyone to create money is that the temptation to over issue it, thus inflating its value, will be irresistible. Linking the creation of new SDRs to finance development is a strong incentive to do just that and it was strongly and rightly rejected. 

The creation of money redeemable for gold, was strongly protected from over issue by that redeemability obligation. This gave the value of gold backed money great stability for many decades. I have proposed issuing (selling) SDRs according to currency board rules linked to an index of real goods and services. This would provide even tighter discipline to the creation of SDRs than existed under the gold standard, and by anchoring its value to a basket of goods rather than to just one (such as gold) it would protect its real value more successfully."

Best wishes,

Added notes:

The Link Between SDR's and Development Finance (Y.S Park 1973) - This paper was looking at this issue of potentially issuing SDRs to finance development in some IMF nations back in 1973 as Dr. Coats refers to above. Here is a quote from page one of this paper (bold emphasis is mine):

"The IMF also recognizes, however, that international monetary reform should include consideration of new measures directly addressed to the needs of developing countries, and most controversial among them is the suggestion that the flows of development aid be supplemented by linking creation of SDRs with assistance to developing countries. This controversy is unique because the link has become a major point of confrontation between the wealthy industrial countries and the poor developing countries."

Dr. Coats pointed out the following in regards to these kinds of proposals in some additional email comments: 

"The earlier and the current discussion focus on the basis of allocating SDRs (using quotas, development need, etc). All of that is swept away when SDRs are issue according to currency board rules. Anyone can buy them who is willing to pay the official price for them."

Dr. Coats wants readers to see the difference between these kinds of proposals which allocate SDR's based on some criteria and his proposal which works completely differently based on Currency Board rules where real assets must be exchanged for any SDR's issued. 

Finally, here is an interesting link to an old formerly classified CIA report on the SDR from 1970 that talks about using the SDR for aid to less developed nations on page 7 in point #14.

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