London 10 November 2015
Ousmène Jacques Mandeng
New Sparta Asset Management
Politicians are eager to stress the need for disruptive policies to bring desired change. One area where disruption is overdue is the global financial architecture. It has remained largely unreformed despite the fact it does not function as intended amid persistent large external imbalances and high exchange rate volatility resulting in considerable welfare losses. It is the IMF Special Drawing Right (SDR) that could offer the needed disruption.
Urban transport provides a useful parallel. The international monetary system is a bit like solving traffic congestion in large city centres. Many traffic problems stem from the use of private cars. Private cars imply many uncoordinated journeys that may eventually result in congestion amid given road space scarcity.
There is plenty of congestion in the international monetary system. Like road space, all current and capital transactions occur in a finite space. Too much traffic in particular around the dollar causes disruptive exchange rate movements. The system faces an old dilemma of using national currencies to manage international liquidity. Prevailing widespread concerns about the international effects of a Federal Reserve interest rate hike serve as a reminder that this dilemma persists unabated.
The adoption of other national currencies—notably the euro but also more recently the renminbi—as international currencies could help ease congestion around the dollar. However, they are likely to simply add traffic to the finite transactions space. Additional international currencies would be more like taxi app UBER.
UBER, hailed as a prime example for disruption, appears to be disrupting traffic flow rather more. UBER aims to maximise car use while large city centres have a collective interest to minimise car use to reduce congestion. It adds to rather than reduces urban traffic problems.
The SDR is the public transport approach to the international monetary system. It was launched in 1969 amid widespread concerns at the time that the international economy is far too congested around the dollar. The SDR is meant to reduce the role of national currencies in international liquidity management. However, it failed to gain reasonable ground in large part due to the dominance of national interests.
SDRs are international reserve assets issued by the IMF. Issuance though is highly dependent on the IMF membership. The SDR never really took off and there have only been three general SDR allocations and by far the largest was only in August 2009. The total stock of SDRs outstanding is about US$280 billion, compared with foreign exchange reserves of about US$11,000 billion. Key IMF member countries have for a long time resisted more SDR issuance on the grounds that actual international liquidity needs would not warrant it. This seems to contradict the large reserve accumulation that occurred concurrently.
The SDR exhibits many ungainly limitations. SDR valuation is simply a weighted average of exchanger rates relative to the dollar. The currencies included in the SDR basket are the dollar, euro, sterling and yen (Table). The weights are based on the share of each currency in world exports of goods and services and international reserves. The valuation is reviewed every five years (with one due by end of this year). The SDR value is thus not based on market forces nor on supply and demand of SDRs and it can be used almost exclusively only for transactions within the IMF. As such the SDR value offers little indication about net demand for international liquidity.
The addition of the renminbi to the SDR basket would offer a bit of innovation—the SDR was made previously of many currencies—but would not address fundamental limitations inherent in the SDR (Table). It could serve as a signalling device that eventually more currencies ought to play a bigger international role in the international monetary system.
The SDR was very innovative. It could also become disruptive. This could happen if there were additional large SDR allocations possibly as substitute for existing reserve assets—similar ideas where developed but never implemented during the 1970s around a so-called substitution account—and be adopted by the private sector. More importantly, the SDR valuation should reflect demand and supply for international liquidity to gauge net allocation needs. SDRs could then be used to address temporary balance of payments problems without need to resort to national currencies thus mitigating currency denomination risks in asset markets.
The introduction of public transport into the international monetary system would exhibit truly disruptive elements. The system does not need more cars. UBER offers the wrong approach. Buses are needed. What matters of course is that people actually take the bus. This in large part rests on the quality of the bus, availability and ease of access. The SDR to play a greater role would require an infrastructure conducive to its use based on some form of institutional arrangement. So far, there has been very little interest among the IMF membership to promote the SDR. It is unlikely to change any time soon. Maybe the international community is just too enamoured with UBER.
*Draft 9 November 2015, as background for panel: The rising role of the RMB in the global financial architecture and the review of the SDR basket: Geopolitics and financial markets.