The international system of payments and reserves
Source: International financial system and development, Report of the Secretary-General United Nations General Assembly, July 2009, pages 14-16
54. The UN Financial and Economic Crisis Conference recognized “the potential of expanded SDRs to help increase global liquidity in response to the urgent financial shortfalls caused by this crisis and to help prevent future crises” (paragraph 35) and called for further studies on this potential. In April 2009, the “G20” decided on a general SDR allocation by the IMF equivalent to $250 billion.
By doing so the world leaders, for the first time since the late 1960s, recognized the need to significantly boost international liquidity using an international reserve unit.
Before the April 2009 decision, the cumulative total of SDR allocations was only SDR21.4 billion (around $32.9 billion).
55. The on-going financial crisis has brought to the fore the deficiencies of the present international monetary system in which a national currency, the United States dollar, serves as a dominant source of international foreign exchange reserves. These deficiencies include growing global imbalances, exchange rate instability and the possibility of erosion of confidence in the dollar as a reserve currency. The widespread use of greater exchange flexibility did not produce exchange rate changes reducing trade and financial imbalances and, in fact, contributed to the inherent instability of the system. Exchange rates adjustments were not sufficient quantitatively, and often in the wrong direction, due to the fact that the US dollar, as reserve currency, serves as a benchmark for many other currencies and an anchor for international asset prices.
56. In the era of globalization, the use by all countries of a widely accepted national reserve currency has its clear benefits due to network externalities. However, the costs of such an arrangement in terms of systemic instability might have started to exceed its benefits. Likewise, the costs for the United States associated with its role as a supplier of global reserves may also be rising. Increased imbalances have had an adverse effect on US domestic demand and on external demand for US products as well as, more generally, on the country’s potential ability to maintain economic policy autonomy.
57. There have been suggestions to move away from the almost exclusive reliance on the United States dollar and towards a system based on multiple, competing national reserve currencies. However, such a system, according to many observers, might add an additional element of instability, associated with exchange rate volatility among currencies – which are close substitutes - used as reserve units due to the possibility of sharp shifts of demand from one international currency to the other. Also, it would not solve the inequalities of the current system, as reserve assets would still be provided by industrial countries. Besides, developed countries issuing reserve currencies are likely to account for an increasingly limited share of the world economy. Hence, the demand for international reserves will likely grow faster than the capacity of these countries to smoothly supply them.
58. Discussions on an international currency have been gaining momentum. The international community should seize this opportunity to start working on the creation of a new, more stable and equitable, international monetary system. While, unlike in the late 1960s, there is no issue regarding the provision of global liquidity, there are problems associated with the control of global liquidity and significant equity issues in the access to such liquidity by developing countries.5
59. The introduction of a full-fledged international reserve currency, based, for instance, on the proposal by Keynes, may take a long time as it requires extraordinary political will, vision and courage, which are still lacking. In this regard, it has been argued that a more realistic way of reform may be a broadening of existing SDR arrangements which, perhaps, over time could evolve into a new and widely accepted world reserve currency.6
60. A step forward would be making SDR issuance automatic and regular. It has been suggested that the size of the issues could be linked to the estimated additional demand for foreign exchange reserves due to the growth of the world economy.
Also, there have been calls to issue SDRs in a counter-cyclical fashion to finance world liquidity and official support to developing countries during crises. One of the versions of the proposal to use SDRs in a counter-cyclical manner envisages the development of an appropriate mechanism to withdraw SDRs should global liquidity become excessive or inflationary. It is also worth noting that the procedure under which countries holding 85 percent of IMF voting power must agree before SDRs can be issued may not be timely if the Fund is authorized to provide additional SDR liquidity in periods of liquidity shortage.
61. It is well understood that making the SDR an attractive unit in which to hold central bank reserves requires deep and liquid markets in SDR claims. To achieve this, the issuance and use of SDRs, by the IMF, governments, banks and nonfinancial firms, needs to reach some critical mass. In other words, it will be necessary to overcome the coordination problem – the prospective issuers should have evidence that others would do likewise. In the past, all attempts to commercialize SDRs were unsuccessful.
62. Another important issue is a settlement mechanism between the SDR and national currencies to make the unit an acceptable means of payment in international trade and financial transactions. Such a system should be able to facilitate the direct exchange of SDR claims not only into dollars but into all constituent currencies.
Also, at present, SDRs are valued against a basket of currencies, consisting of the euro, Japanese yen, pound sterling and US dollar. For the SDR to gain global prominence, the number of constituent currencies should be increased to include monetary units of both developed and developing countries.