Money, it is commonly known, possesses several distinct but interrelated characteristics. Any monetary system requires a unit of account, or numeraire, in which to express other relative values; a store of value, or temporary abode of purchasing power, to bridge the gaps between nonbarter purchases and sales; and a medium of exchange in which payments are made or by which financial obligations are settled. While money has traditionally served all three functions, the only one that is unique and essential is that of payments medium. The use of money as a monetary system’s numeraire is so widespread as to impede thinking about the use of any other unit of account. Yet gold is an often discussed alternative unit of account with a long history. Those who propose a gold standard do not generally envisage the actual circulation of gold as the medium of exchange, although the fact that gold has played that role in the past tends to cloud our thinking about the separability of its unit of account and medium of exchange functions. Professors Leland Yeager and Robert Greenfield have sharply distinguished the two functions in a fascinating exploration of a monetary system in which the government provides only the unit of account. One unit is precisely and invariantly defined as fixed quantities of a broad basket of goods.1 In their system the government does not issue money of any kind, but private contracts and means of payment are denominated in the government unit.

Abstract

Money, it is commonly known, possesses several distinct but interrelated characteristics. Any monetary system requires a unit of account, or numeraire, in which to express other relative values; a store of value, or temporary abode of purchasing power, to bridge the gaps between nonbarter purchases and sales; and a medium of exchange in which payments are made or by which financial obligations are settled. While money has traditionally served all three functions, the only one that is unique and essential is that of payments medium. The use of money as a monetary system’s numeraire is so widespread as to impede thinking about the use of any other unit of account. Yet gold is an often discussed alternative unit of account with a long history. Those who propose a gold standard do not generally envisage the actual circulation of gold as the medium of exchange, although the fact that gold has played that role in the past tends to cloud our thinking about the separability of its unit of account and medium of exchange functions. Professors Leland Yeager and Robert Greenfield have sharply distinguished the two functions in a fascinating exploration of a monetary system in which the government provides only the unit of account. One unit is precisely and invariantly defined as fixed quantities of a broad basket of goods.1 In their system the government does not issue money of any kind, but private contracts and means of payment are denominated in the government unit.

Money, it is commonly known, possesses several distinct but interrelated characteristics. Any monetary system requires a unit of account, or numeraire, in which to express other relative values; a store of value, or temporary abode of purchasing power, to bridge the gaps between nonbarter purchases and sales; and a medium of exchange in which payments are made or by which financial obligations are settled. While money has traditionally served all three functions, the only one that is unique and essential is that of payments medium. The use of money as a monetary system’s numeraire is so widespread as to impede thinking about the use of any other unit of account. Yet gold is an often discussed alternative unit of account with a long history. Those who propose a gold standard do not generally envisage the actual circulation of gold as the medium of exchange, although the fact that gold has played that role in the past tends to cloud our thinking about the separability of its unit of account and medium of exchange functions. Professors Leland Yeager and Robert Greenfield have sharply distinguished the two functions in a fascinating exploration of a monetary system in which the government provides only the unit of account. One unit is precisely and invariantly defined as fixed quantities of a broad basket of goods.1 In their system the government does not issue money of any kind, but private contracts and means of payment are denominated in the government unit.

The International Monetary Fund employs similar basket methodology in defining the unit of account that it uses in denominating the currency obligations to the Fund of its members and its other assets and liabilities, in maintaining its accounts, and in publishing its financial statements. The Fund’s unit, the special drawing right (SDR), is defined as a basket of five major currencies.

However, the Fund’s creation of the SDR in the late 1960s was motivated by the desire to augment world liquidity at a time of rising world trade and a gold-linked value of the U.S. dollar and other major currencies.2 Accordingly, an asset was created that could be held in the official reserves of member countries and could be used as a means of international payment. This asset was denominated in SDR units. These so-called official SDRs3 have been used by member countries primarily in dealings with the Fund and for the purchase of other reserve currencies when balance of payments financing has been needed. In short, their use as a means of payment has been very limited. Over time, they have become an increasingly attractive store of value (i.e., reserve asset in foreign asset portfolios) but not a frequently used medium of exchange. They have not yet achieved the full status of money. This paper reviews the SDR’s characteristics and puts forth an idea for enhancing its attractiveness as a means of payment that involves the use of official SDRs for settling international movements of private SDRs.

I. Official SDRs

The SDR is currently defined as the sum of 0.54 U.S. dollar, 0.46 deutsche mark, 0.74 French franc, 34.0 Japanese yen, and 0.071 pound sterling. The U.S. dollar value of this basket of five currencies is computed daily on the basis of the noon mid-rates in London, which are supplied to the Fund by the Bank of England. The Fund has thereby created a unit of account with a number of interesting and useful characteristics that has found a growing number of uses both within and outside the Fund.

The SDR’s definition, as a basket of fixed quantities of currencies, has the property that the contribution of each component currency to the value of the SDR varies with its relative exchange value. It has the additional property that its value relative to many other individual currencies is often more stable than is the value of a single currency. This stability, and the relatively low inflation rates in the five countries whose currencies are currently in the basket, has made the SDR a unit of account with more stable real value than that of many other units.

The Fund’s SDRs (i.e., the asset) were first allocated in January 1970 to Fund members participating in the SDR scheme; all Fund members are now participants. In addition, 12 official entities, generally regional central and development banks, have been prescribed as “other holders” of SDRs.4 These prescribed holders do not receive allocations of SDRs, but they maintain accounts with the Fund’s Special Drawing Rights Department and can otherwise acquire and use SDRs in the same way as participating members.

Official SDRs are a liability not of the Fund but of the participants receiving allocations when the size of an allocation has been agreed upon. SDRs are allocated to participants in proportion to their quotas in the Fund; they carry with them the obligation for the participant to provide freely usable currencies of equivalent value should the scheme be terminated and to pay charges on cumulative allocations at a rate equal to the rate of interest earned on average holdings of SDRs. Allocations also carry the obligation for countries with a sufficiently strong balance of payments to accept SDRs, in amounts up to twice their allocation, from participants with a weak balance of payments position. Along with the liabilities attached to allocations, participants receive assets of the same amount. If allocated SDRs are never used by a participant and SDRs are never acquired by it in any way, that is, if a participant’s SDR allocations (liability) and its SDR holdings (asset) remain equal, no net interest is paid or received and the scheme is similar to an unutilized line of credit for that participant.

Initially, this line of credit provided a subsidy to countries using SDRs (i.e., those with balance of payments deficits) from those acquiring them,5 because until mid-1981 the rate of interest on SDRs was well below market rates on balance of payment loans. This line-of-credit characteristic of the SDR is a detail of its creation and does not prevent it from being money.6 The SDR is both a medium of international payments (among participants and other holders) and a store of value, although it has some characteristics unique to itself.

As a reserve asset it has the peculiarity, when compared with other reserve currencies, that it is its own interest-yielding investment, usable (in principle) on demand, and paying a single rate of interest. Furthermore, the denomination of a unit of the asset as one SDR means that its market price cannot adjust so as to equilibrate its rate of interest to those prevailing in the market. This makes it difficult to maintain a balance between supply of and demand for the asset and, thus, its liquidity. In practice, at this early stage in the SDR’s development, it also possesses uncertain liquidity in that it can be used on demand with certainty only in the event that a participant has a balance of payments need. Other reserve currencies can be invested in a great variety of instruments of differing maturities and yields and can be used or exchanged for other currencies at short notice and at low costs.

The official SDR has several advantageous qualities as a result of its being both the creation of and in the safekeeping of an international body with a large and diverse membership. As recent impoundments of the financial assets of one country maintained in another remind us, there is value in holding foreign assets in forms that are not subject to the risk of national seizure. The desire to escape sovereign risk gave rise to the Eurodollar market, as the Soviet Union arranged to hold U.S. dollar assets through (with) European banks rather than directly in the United States. While that arrangement makes it more difficult for the United States to impound such assets, they remain subject to the risk of impoundment by European governments. Comparable action with regard to foreign exchange reserves held as SDRs with the Fund’s Special Drawing Rights Department would require agreement by an 85 per cent majority (by quota) of its 146 members; in other words, it is almost unthinkable, given the diversity of the Fund’s membership. Even the international character of gold is hampered, as a practical matter, by the need to maintain it in international financial centers, such as New York or London, where it remains vulnerable to seizure, or to physically transport it around the world, which makes it a costly and clumsy medium of payment.

The unique manner in which the quantity of SDRs is expanded also gives rise to some special observations.7 For some purposes, the relationship of holdings to allocation (i.e., the extent to which the credit line has been drawn—or the special drawing right exercised) has a significance, and for others it does not.

Gross reserves can be acquired through the balance of trade (i.e., in exchange for real resources) or by borrowing them. There is the difference for SDRs that acquiring them through allocation is equivalent to establishing a line of credit rather than to drawing on one. SDRs allocated by the Fund are therefore an addition to world liquidity in the same way as are other lines of credit, with the difference that the SDRs used need never be repaid. Such credit lines are not generally considered part of a country’s foreign exchange holdings, although they clearly contribute to its international liquidity. Such a perspective suggests that only SDRs held in excess of a participant’s allocations should be viewed as part of its foreign reserves. The Fund’s practice, however, is to include a country’s total holdings of SDRs in the foreign reserves reported in International Financial Statistics (IFS) on the grounds that they are readily usable for financing international trade. As with the appropriate definition of domestic money, whether overdraft or credit line facilities should be included or not can be resolved only empirically.

Using SDRs, however, is like using any other reserve asset as far as the interest rate is concerned, in that the interest that would have been earned is forgone. This is equally true whether the user’s holdings of SDRs are above, at, or below its allocations, and, hence, whether the participant receives net interest or incurs net costs on its holdings. The irrelevance of the relation of holdings to allocations for the marginal decisions of using or receiving SDRs is perhaps most clearly seen for other holders, who have no allocations. They come by their SDRs the same way that they come by any other reserve asset, basically by giving up real domestic resources, and they earn the SDR rate of interest on whatever amount they hold. In using these SDRs they forgo that interest whether they have charges on allocations or not. Put differently, the composition and management of a foreign reserve portfolio of given size is not dependent on whether some part of gross reserves is borrowed.8

II. Private SDRs

The value of a more stable unit of account in the current environment of generally floating exchange rates has fostered the use of the SDR unit of account outside the Fund. An interesting example is the development of SDR-denominated deposits with commercial banks. These so-called private SDRs serve all the basic functions that are served by the Fund’s official SDRs. However, as long as private SDRs are created in exchange for an equivalent amount of national currencies, they do not augment world liquidity in the way that official SDRs do.9

SDR-denominated deposits are being offered on varying terms by an increasing number of commercial banks. Private SDRs are subject to rules agreed upon between depositors and depositories and are in no way constrained by the rules for the uses of official SDRs. Private SDRs pay interest agreed upon by depositors and depositories that is in no way limited by the interest paid on official SDRs. What gives these deposits the SDR designation is the use of that unit of account. The value of private SDRs in exchange for other currencies is generally determined on the basis of the same basket of currencies as the Fund’s official SDR.10 While the official SDR is valued once a day on the basis of noon rates in London, private SDRs are often revalued continuously throughout the day, but by virtue of their being designated SDRs, those valuations are based on the Fund-determined basket of currencies.

III. Enhancement of the SDR

With the adoption of the Second Amendment to the Fund’s Articles of Agreement in 1978, members reaffirmed their intention of “making the special drawing right the principal reserve asset in the international monetary system.”11 Achievement of this objective requires making SDRs sufficiently attractive in those characteristics that have historically been associated with reserve assets and making the amount of SDRs sufficiently plentiful.

In the effort to enhance the SDR’s role as an international reserve asset, the Fund has modified it in a number of ways that are designed to increase its attractiveness. The calculation of its value was simplified in 1981 by reducing the number of currencies in the basket from 16 to 5, thereby enhancing its usefulness as a unit of account. The interest rate on the official SDR was also raised the same year to 100 per cent of a basket of government or prime securities in the same five countries and with the same weights as in the currency basket. The ways in which the SDR can be used have also been expanded.

The 1981 simplification of the composition of the currency basket also helped the development of the private SDR by making it easier to cover the exchange exposure in foreign exchange markets resulting from the acceptance of SDR-denominated deposits. This practice reflects the unbalanced growth of SDR-denominated instruments on bank balance sheets, that is, the dearth of SDR-denominated bank assets relative to liabilities. As long as this condition persists, the private SDR will remain more a currency cocktail than a currency unit in its own right.

To date SDRs, both private and official, are only occasionally used for the settlement of financial obligations other than those with the Fund. When SDRs are used outside the Fund, they are almost invariably converted into a vehicle currency first. This may partially reflect the history of the SDR’s creation, which focused on its reserve asset characteristics—that is, its use as a form in which to hold reserves. It may also have roots in the SDR’s earlier connection with gold, a once (and possibly still) prized component of reserve portfolios. From this perspective it seems natural that SDRs, like gold, are generally exchanged for currency before being used to settle international financial obligations.12

In addition, the direct use of SDRs outside the Fund is being held back by the lack of established arrangements for settling direct payments in private SDRs. The full potential of the SDR as a reserve asset is not likely to be realized without the development of some such arrangements. Increased use of the SDR unit for invoicing internationally traded goods and services or for setting values or amounts of obligations in other international contracts or conventions would increase the demand for the ability to settle directly in SDRs, and hence the incentive for the market to develop the clearing arrangements necessary for such payments. On the other hand, the existence of such arrangements would make it more attractive to invoice in SDRs.

The medium-of-exchange qualities of a reserve asset are not really separable, except analytically, from its attractiveness as a store of value. The ease with which payment can be made directly with a reserve asset helps to determine its liquidity and general attractiveness. The freely usable currencies in the SDR basket have these characteristics and, hence, set the standards that the SDR itself must meet if it is to be as attractive. One of the most important steps that can be taken to further enhance the role and use of SDRs will be to enable, encourage, and promote their direct use in the settlement of financial obligations. This requires the development of efficient and convenient arrangements for clearing payments in private SDRs between banks and between countries.

IV. Clearing Arrangements

Clearing arrangements take many forms, each involving in one way or another an unbroken chain between the payer’s and the payee’s banks. If the two banks maintain accounts with each other, settlement is effected by the bank of the person receiving payment reducing the account of the paying bank with itself. Handling all payments in this way could require a staggering number of interbank accounts. The United States, for example, has more than 15,000 banks and many more branches. Therefore, the practice has arisen in the market of concentrating interbank deposits with a few clearing (correspondent) banks. As long as the payer’s and the payee’s banks each maintain accounts with adequate balances with the same third bank, settlement can be effected by the appropriate debiting and crediting of their accounts with that third bank. If the net flow of payments through these correspondent clearing accounts tends to exceed the amounts on deposit, the shortfall can be covered by an extension of credit by the clearing bank to the paying bank or by an infusion of additional reserves by the paying bank to its account with its correspondent. This is generally accomplished by appropriate debiting and crediting of each bank’s account with their common central bank. Thus, ultimate settlements of currency payments are made by the central banks that have issued the national currencies in question.

For the SDR, the Fund plays a role similar to that of a central bank with respect to its own national currency. This suggests that SDR accounts with the Fund (i.e., official SDRs) are likely to play an analogous role in the development of clearing arrangements for the private SDR, although any other agreed depository, in which all commercial banks or their correspondents maintained accounts, could be used.

The separation between official and private SDRs is often thought to be an impediment to this development. Specifically, it is often felt that the limited number of holders of the official SDR limits its usefulness as a settlement asset. What follows is a description and discussion of how official SDRs could be used in conjunction with private SDRs in the settlement of financial obligations without expanding the number of account holders in the Fund’s Special Drawing Rights Department.13 An example of such integration of “official” and “private” money at the national level is provided by commercial bank use of official money (holdings in accounts with their central banks—accounts not generally available to individuals) to facilitate the transfer of private money (individuals’ deposits with commercial banks).

As the arrangement proposed here is an unfamiliar one, it may be helpful to describe analogous, but more familiar, clearing arrangements currently in use for national currencies. The banking arrangements and institutions of the United States will be used for this purpose. To help to crystallize the distinction and the relationship between private and official SDRs, this terminology will also be used in distinguishing base money from bank money.14 The attractiveness of ultimate settlement in official SDRs, rather than using a central bank or some other common depository, resides in the Fund’s international character.

Payment clearing and settlement arrangements are at the heart of the use of deposit money in the discharge of financial obligations. In the United States, many payments are cleared and settled through private clearinghouses. This process generally involves the accumulation of individual payment instructions between various commercial banks during the course of the day, netting out the crossflows, and settling any net differences either multilaterally or bilaterally with official dollars (or by converting balances due into loans, or by increasing and decreasing correspondent or clearinghouse accounts) at a particular time in the day.15 However, a great number of payments are also cleared and settled directly through the Federal Reserve System.16 Either approach generally involves the interlinked uses of official and private dollars in the settlement process. This is the prototype of a proposed development for handling the SDR.

Take a highly simplified example in which Person A makes payment to Person B of, let us say, $100. It does not matter whether payment is effected by Person A presenting Person B with a check that is then cleared through the system or by wire—telexed payment instructions—from Person A’s bank (Bank A) to Person B’s bank (Bank B). As wire transfers are the mode of payment instructions for SDRs, that example will be taken here. Bank A would wire Bank B with the instruction to increase the account of Person B by $100 on behalf of Person A, and with the information that Bank B’s account with the Federal Reserve was being increased by $100. Bank A would also wire the Federal Reserve with the instruction to reduce its own account by $100 and to increase Bank B’s account by the same amount. In this way, private U.S. dollars are transferred from Person A to Person B through the facilities of the banking system. This transfer is facilitated, and in this instance made possible, by the simultaneous use and transfer of official U.S. dollars between Banks A and B.

The United States actually has 12 Federal Reserve Banks within the Federal Reserve System, so that if Person A resides in Washington, D.C. and is making payment to Person B who resides in San Francisco, California, the clearing arrangements require an additional step. For Bank B to collect from Bank A the funds that it is adding to the account of Person B, it must arrange to move funds between two Federal Reserve Banks. Bank A instructs its Federal Reserve Bank (Federal Reserve Bank A) to reduce its account by $100 and to increase the account of Bank B with Federal Reserve Bank B in San Francisco by the same amount. These instructions are then passed from Federal Reserve Bank A to Federal Reserve Bank B and are executed with appropriate adjustments on the Federal Reserve’s own books between its two Reserve Banks. Conceptually, this last step can be imagined as taking place on the books of a higher-level body, in this case the Federal Reserve Board, which would reduce the account of Federal Reserve Bank A by $100 and increase the account of Federal Reserve Bank B by the same amount.

V. Linking Private and Official SDRs

To see how the combined use of official and private SDRs might be used to settle private SDR payments, simply replace U.S. dollars with SDRs in the preceding example. Replace Federal Reserve Banks A and B with the Bank of England and the Deutsche Bundesbank, and replace the Federal Reserve Board at the pinnacle of this network with the Fund’s Special Drawing Rights Department. A payment of SDRs by Person A in England to Person B in the Federal Republic of Germany is ultimately settled by a transfer of SDRs from the Bank of England’s account at the Fund to the Bundesbank’s account at the Fund. Official holdings of SDRs move from England to Germany in settlement of a private SDR payment from England to Germany. The Fund being the institution in which both the payer and the payee maintain accounts enables the final link to be established in the chain of payment without the physical shipment of currency.17 The transfer is an internal bookkeeping activity.

The one element of this example that is missing from the current financial scene is the implied existence of commercial bank deposits with their central banks denominated in SDRs. Such SDR clearing deposits are necessary (in addition to the traditional domestic currency—commercial bank deposits with their central banks) for the foregoing procedure to operate.

The resulting adjustments on the books of the institutions involved are depicted in Table 1. For example, the books of Bank A show a reduction in Person A’s SDR account (– PA) and a reduction in the item “SDRs due from Central Bank” (– CBA), that is, a reduction in Bank A’s SDR deposit with CBA. This reduction is reflected in Central Bank A’s books as a reduction in Bank A’s SDR account (–BA), etc.

Table 1.

Accounting for Payment in SDRs from Person A to Person B

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Central banks generally operate under rules governing their foreign exchange exposure. Opening SDR-denominated clearing accounts for the commercial banks operating within their borders might be seen as creating such an exposure. Domestic currency, or more likely foreign currency, would be paid in and exchanged for an SDR liability of the central bank that in the first instance would not be covered by SDR-denominated assets.18

Current accounting practices generally treat SDR allocations as a central bank liability matched against the initially equal SDR holdings on the asset side. As SDRs are used or accumulated, there will no longer be an asset/liability balance in SDRs. If, however, the liability of allocations were carried on the books of some other agency of the government (e.g., the Finance Ministry), and the central bank opened SDR-denominated private deposits with its commercial banks on the liability side of its books, the central bank might strive to adjust by matching its official SDR assets against its private SDR liabilities.19 As is seen in Table 1, operations of the clearing arrangements described here do not alter the central banks’ foreign exchange exposure, while net foreign trade and capital flows will continue to alter a country’s net foreign assets.

One of the implications of this view of the role of official SDRs as a settlement asset in facilitating private payments is that central banks or official institutions performing central banking functions are the appropriate holders of official SDRs. From this perspective, there is little advantage in adding development banks or similar institutions to the list of other holders. However, development banks can play an important role in the promotion of SDRs by utilizing the SDR unit of account, engaging in contracts denominated in SDRs, and, more important, by making and receiving payments (loan disbursements and repayments, capital subscriptions, etc.) in private SDRs. Their official SDR holdings would not be of particular benefit in these activities, inasmuch as these types of institution do not perform a payments clearing and/or settlement function. Encouraging central banks to open SDR-denominated deposits for commercial banks and acquainting potential users (such as development banks, the International Air Transport Association, the Organization of Petroleum Exporting Countries, and other international consortia) with the potential for the clearing arrangements outlined earlier could, in time, enormously enhance the use of both official and private SDRs.

This brings us to a brief consideration of whether the Fund’s objectives are better served by encouraging the development of one type of SDR rather than the other. One important difference between official and private SDRs is that an increase in the quantity of official SDRs via an increased allocation to participants (as opposed to official substitution or an allocation to the Fund) increases the stock of world liquidity, whereas an increase in private SDRs, to a first approximation, does not. The increase in private SDRs is generally at the expense of deposits denominated in national currencies and, hence, leaves total deposits unchanged, although potentially changing their currency mix. Considerations of international liquidity, therefore, have implications primarily for the stock of official SDRs. Whether the Fund should otherwise encourage the development of one form of SDR over the other must depend on the additional purposes for which it desires to make SDRs the principal international reserve asset. To the extent that this is seen as providing the world with an asset that has a reasonably constant value in the hopes of constructing a more stable international payments system, the widest possible development of private SDRs (with an appropriately supportive quantity of official SDRs) is to be encouraged.

VI. Conclusion

If the attractiveness of the official SDR is kept competitive with other official reserve assets, the development and expansion of the private SDR is complementary to the further development of the official SDR. Direct use of either form of SDR in making payments is an important part of its development as a useful reserve asset. The development of clearing arrangements is an essential element in the use of SDRs for making payments. These arrangements take many forms and through time the market tends to evolve several interconnected arrangements simultaneously, such that payments are cleared in the most economical manner. Thus, we observe the coexistence of correspondent clearing banks, citywide or regional clearinghouses, and central bank clearing accounts. For the SDR, it is possible if not likely that market participants will evolve a role for the Fund’s official SDR in the clearing process, possibly similar to the one outlined in this paper.

*

Mr. Coats, Chief of the Operations Division for SDRs and Administered Accounts in the Treasurer’s Department, is a graduate of the University of California at Berkeley and the University of Chicago. He was formerly Assistant Chairman of the Economics Department at the University of Virginia. He has published widely on monetary policy issues and was coeditor, with Deena R. Khatkhate, of Money and Monetary Policy in Less Developed Countries (Oxford and New York, 1980).

1

Robert L. Greenfield and Leland B. Yeager, “A Laissez Faire Approach to Monetary Stability” (mimeographed, University of Virginia, March 1982).

2

At that time, the SDR was defined as a fixed quantity of gold, hence its popular designation as “paper gold.”

3

To distinguish the SDRs allocated by the Fund, that is, those maintained on accounts with the Fund’s Special Drawing Rights Department, from SDR-denominated deposits with commercial banks, the shorthand expressions “official” and “private” SDRs have come into fairly widespread use in financial circles. These terms are used in this paper in the same way.

4

These are the Andean Reserve Fund, Bogotá; the Arab Monetary Fund, Abu Dhabi; the Bank of Central African States, Yaoundé; the Bank for International Settlements, Basle; the Central Bank of West African States, Dakar; the East Caribbean Currency Authority, St. Kitts; the International Bank for Reconstruction and Development, Washington; the International Development Association, Washington; the Islamic Development Bank, Jeddah; the International Fund for Agricultural Development, Rome; the Nordic Investment Bank, Helsinki; and the Swiss National Bank, Zurich.

5

Countries with a “balance of payments need” can require countries whose balance of payments and reserve positions are “sufficiently strong” to accept SDRs in exchange for currency through a “designation” mechanism.

6

This is analogous to central bank lending, which is both the use of a line of credit and an expansion of money.

7

The basis of allocation, that is, a participant’s quota in the Fund, has also been the subject of considerable discussion. Proposals to “link” allocations to need (i.e., to expand world liquidity by granting subsidized credit lines (SDRs) to the poorer countries) have been rejected in the past on the political grounds that aid-related motivation for allocating SDRs should not cloud liquidity-related motivation.

8

To the extent that debt obligations in a particular unit must be repaid and it is desired to cover the resulting foreign exchange exposure, assets in the same unit might be held for that purpose if new inflows were not expected to be sufficient to cover such obligations. SDRs never need to be repaid (unless the scheme is liquidated); therefore, this particular issue does not arise. For countries with a sufficiently strong balance of payments, however, use of SDRs may subject them to potential designation (i.e., the compulsory repurchase of SDRs).

9

To the extent that borrowing in private SDRs expands a country’s borrowing capacity, the creation of private SDRs could expand world liquidity. Likewise, the creation of private SDRs in exchange for one’s own domestic currency increases foreign exchange at the expense of domestic money but to a first approximation leaves the aggregate unchanged. Furthermore, such shifts may free or impound bank reserves and hence affect their lending ability owing to differing requirements for different categories of deposit.

10

The exceptions relate to those periods of transition following the periodic (generally every five years) changes in the Fund’s definition of the SDR, as when the basket was reduced from 16 to 5 currencies in 1981. Three basic approaches have evolved in commercial markets. (1) The “current” definition always follows exactly the Fund’s definition. This is also called the open-basket approach. All SDR-denominated bonds follow this approach. (2) The “constant” definition retains the definition in place when a transaction was initiated regardless of any changes made in the Fund’s definition. This is also called the closed-basket approach. Fixed-term time deposits and short-term certificates of deposit follow this approach. (3) The “lagged current” definition adopts any changes in the Fund’s definition but only at the beginning of the next interest period. This approach is followed by most floating rate deposits or loans. These practices reflect the desire of most banks to maintain covered foreign exchange positions and the current paucity of SDR assets with which to match liabilities. As a result, banks tend to construct an asset match with the 5 constituent currencies that cannot be adjusted for changes in the Fund’s definition within the course of a transaction without some cost.

11

Articles of Agreement of the International Monetary Fund (Washington, April 1, 1978), Article VIII, Section 7; Article XXII.

12

Private SDR settlements increasingly avoid the conversion problem by paying in the five component currencies, so that no currency exchange is involved.

13

The Committee of Twenty also considered the indirect use of official SDRs by commercial banks as part of an exchange rate intervention system. The scheme would involve central banks dealing with commercial banks in their own currency against the SDR on the condition that the commercial banks were only intermediating movements of SDRs between central banks. Committee on Reform of the International Monetary System and Related Issues (Committee of Twenty), “Report of Technical Group on Intervention and Settlement,” International Monetary Reform: Documents of the Committee of Twenty, International Monetary Fund (Washington, 1974), pp. 122–25.

14

Pesek and Saving have used the terminology “private money and government money,” although they also use the more common economic expressions “outside and inside money,” “commodity and fiat money,” “bank money,” and even the old term, “hard and credit money.” The Fund’s definition of money in IFS and the definition of narrow money (A/,) in the United States consist of only a part of bank money and only a part of government (base, high-powered, outside) money. See Boris P. Pesek and Thomas R. Saving, Money, Wealth, and Economic Theory (New York, 1967) and The Foundations of Money and Banking (New York, 1968).

15

William J. Byrne has explored the possible involvement of the Fund as a clearinghouse for private SDR payments. “Aide-Memoire Concerning Clearing Arrangements for U.S. Dollars, ECUs and Eurobonds, and Their Implications for SDR Clearing Arrangements” (unpublished, International Monetary Fund, June 29, 1981). Use of official SDRs in private clearing arrangements is also discussed in UNDP/UNCTAD, Project INT/75/015, Studies on International Monetary and Financial Issues for the Developing Countries: Measures to Strengthen the SDR, Report to the Group of Twenty-Four, UNCTAD/MFD/TA/11 (Geneva, March 1981), pp. 12–13.

16

These arrangements and related issues are explored by Warren Coats, Jr. and Allen Frankel in The Effects of Prohibiting Reserve Account Overdrafts, Research Papers in Banking and Financial Economics, Board of Governors of the Federal Reserve System (Washington, September 1980).

17

The convenience of a central bank depository is dramatized by the fact that even gold settlements were rarely made by actual physical shipments. Rather, the facilities of the Federal Reserve Bank of New York’s or the Bank of England’s vaults, where most countries store gold, were used. Ownership of this gold would change hands without the gold ever leaving the vault.

18

If foreign currency (e.g., the five component currencies of the SDR) were required to establish or replenish these SDR-denominated clearing accounts, the central bank’s clearing activity would have a neutral impact on the nation’s foreign exchange position and movements. The foreign exchange of the banking system that would have been paid out in the form of currencies would in the scheme proposed here be paid into the central bank, which in turn would pay out official SDRs.

19

The capacity for this use of SDRs to expand depends, in part, on sufficient allocations of official SDRs.