The PBoC’s call for a new global currency, the SDR, the US and the IMF

A $200 billion shared pool of reserves ($250 billion counting the IMF’s supplementary credit line) is tiny relative to the world’s $7000 billion in national reserves, or -- more importantly -- relative to the emerging world’s short-term external debt. The IMF currently lacks enough funds to be a lender of last resort for Eastern Europe, let alone the world. George Soros:

"capital is fleeing the periphery and it is difficult to rollover maturing loans. .... To stem the tide, the international financial institutions (IFIs) must be reinforced ... the fact is that the IMF simply doesn’t have enough money to offer meaningful relief. It has about $200 billion in uncommitted funds at its disposal, and potential needs are much greater."

A bigger IMF implies a somewhat larger role for the IMF’s unit of account: the Special Drawing Right (SDR), itself a basket of dollars, euros, pound and yen. When the IMF lends, its loans are denominated in SDR – not dollars, euros or yuan. China may argue that SDR-denominated lending is the first step toward creating a new “supranational” reserve currency. But that is a stretch. No one made such an argument back when the IMF was making a lot of SDR-denominated loans to Asia in the 1990s.

The IMF pools contributions from many countries, so denominating its accounts in a composite of the world’s main currencies make sense. Using the SDR inside the IMF isn’t a threat to the US dollar either. Last I checked, the dollar has somehow managed to maintain its position as the world’s leading reserve currency even though United States’ contribution to the IMF (its quota) is measured in SDR.

Indeed, the SDR – as the IMF explicitly recognizes on its website – isn’t actually a currency.

“The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members.”

Countries intervene in the foreign exchange market with dollars and euros not SDR. An IMF loan is just denominated in SDR – so the amount a country has to repay doesn’t change all that dramatically when the dollar moves v the euro. In practice countries actually want to borrow "freely usable currencies" not SDR. In other words, they generally want dollars and euros.

As Dan Drezner observed, many traders presumably hadn’t read Governor Zhou’s white paper or spent much time brushing up on the mechanics of the SDR . They consequently read a bit too much into the headline that was slapped onto Geithner’s comments at the Council. Macroman is right:

"Geithner said that .... he was certainly open to expanding the pool of IMF SDRs. This was an innocuous enough comment, as the IMF is likely set to see its funding levels increase dramatically."

Deal Journal is wrong; Geithner never said he was only open to "abandoning the U.S. dollar as the primary global reserve currency." He was open to increased "use of the IMF’s special drawing rights" but he also said this was "rather evolutionary, building on the current architectures, than -- rather than -- rather than moving us to global monetary union."

Indeed, Zhou’s call for a one time SDR allocation (an SDR allocation is complicated ** but it effectively is a way for the advanced economies to help meet emerging economies need for hard currency reserves) is less radical than Martin Wolf’s call for an annual SDR allocation. Soros also wants an annual allocation as long as the crisis lasts. Wolf hopes an annual SDR allocation would allow emerging economies to build up reserves without running large current account surpluses.

A one time SDR allocation to increase the emerging world’s access to dollars and euros (the main current reserve currencies) is quite different than redenominating all of the world’s reserves into SDR. The world’s reserves couldn’t actually be redenominated in SDR unless the US and a host of eurozone countries started issuing a ton of SDR debt to replace all the dollar-denominated Treasuries and euro-denominated bunds, OATs and BTPs*** -- now held as part of the world’s reserve portfolio. That isn’t about to happen.

I am still struggling to understand precisely what motivated Governor Zhou’s white paper.

One possibility is that he wanted to highlight the fact that the IMF doesn’t operate in dollars to help “sell”a bigger Chinese contribution to the IMF at home. Zhou can argue that China isn’t handing dollars over to a US dominated institution, as some might think. Or helping to bail out a bunch of countries in Eastern Europe peripheral to China’s national interest. By providing the IMF with SDR, China can argue that it is contributing in a small way to the creation of a new reserve currency.

The Journal’s Batson hints as such a motivation when he reports:

"China has resisted the U.S. push to make an immediate loan to the IMF because that wouldn’t give China a bigger vote. Ms. Hu said Monday that China, which encourages the IMF to explore other fund-raising options, would consider buying into a bond issue. The IMF has been working on a proposal to issue bonds, probably only to central banks"

Of course, Zhou’s call for a new global reserve currency was also intended to signal China’s concern about the direction of US policies. And just perhaps, to signal that China’s government is taking domestic criticism that it has squandered China’s savings to heart.

It some ways Zhou’s call is a sign of weakness as much as a sign of strength, as China’s leaders are now is clearly worried about the value of its reserve portfolio. Or perhaps they are just worried about being blamed for losses on China’s reserve portfolio.

Chinese policy makers are sophisticated enough to know that the US is not going to embrace a true supranational currency. Agreeing to a world where the IMF calculate its accounts in a basket of dollars, euros, pound and yen is one thing. Agreeing to a new currency that supersides the dollar is quite another.

Moreover, China’s call for a change in the global order is rather undermined by China’s ongoing desire to peg to the plain old dollar.

A discussion of reserve currencies ultimately is also a discussion about the exchange rate regimes that led a host of emerging economies to accumulate reserves. Zhou’s call puts some issues that China hadn’t wanted to discuss at the last leaders meeting on the table for international discussion.

Perhaps China’s leaders wanted to insulate their dollar peg from criticism, both at home and abroad, by arguing that they cannot change their peg without a broader change in the international monetary regime. China can argue that if the US doesn’t want to abandon the dollar, China shouldn’t be pushed to abandon its dollar peg.

The only problem is that there is no real link between the two issues. China could easily join those emerging economies that already allow their currencies to float against the dollar and the euro even in the absence of any agreement on a new global currency.

In a lot of ways, though, the most surprising proposal in Zhou’s paper wasn’t his call for a new global currency; it was his call for “international” management of national reserves. Zhou wrote:

Compared with separate management of reserves by individual countries, the centralized management of part of the global reserve by a trustworthy international institution with a reasonable return to encourage participation will be more effective in deterring speculation and stabilizing financial markets .... With its universal membership, its unique mandate of maintaining monetary and financial stability, and as an international "supervisor" on the macroeconomic policies of its member countries, the IMF, equipped with its expertise, is endowed with a natural advantage to act as the manager of its member countries’ reserves

That would really be a change. China currently isn’t willing to tell the IMF the currency composition of its reserves. And now it seems to be hinting that it might allow the IMF to manage a portion of its reserves!****

Chinese policy makers increasingly seem to view China’s large reserves as a burden, not as an opportunity.

Unfortunately, China is already stuck with this burden. In some sense, the current debate in China over the cost of maintaining a large reserve portfolio is a debate China should have had four or five years ago. Back then it was clear that China had put itself on a path that would lead it to accumulate huge reserves at a substantial cost to itself. It didn’t change though. As a result, it ended up providing a lot of dollar-denominated credit to the US over the last four years.

Now it is struggling to accept the consequences of the policy choices that left it with over 50% of its GDP in reserves or quasi-reserves.

That presumably is why previously unthinkable options – like global management of China’s reserves – seem to be getting serious consideration.

*”Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions.”

** As I understand it, the IMF grants all countries SDRs. And then emerging economies can use their SDRs as collateral to borrow dollars and euros and the like from the central banks of the world’s advanced economies. It is a way countries that don’t have currencies of their own that the Fed is willing to accept as collateral in swaps can get hard currency reserves. If there is a better explanation, I am all ears.

*** German, French and Italian government bonds

**** Dr. Summers, in his academic days, made a similar proposal.