Can IMF currency replace the dollar?

World leaders at the G-20 meeting agreed to create new international money worth $250 billion. The IMF will oversee the new money called SDRs (Special Drawing Rights). Some people believe — and China fervently hopes — that SDRs will in due course replace the dollar as the main world reserve currency.

I, however, am a sceptic. I doubt if the amount of SDRs will ever rival the dollar, euro or yen. Far from becoming a separate international currency, the SDR will remain a derivative of the dollar and a few other major national currencies.

Before World War I, most countries were on the gold standard: currency issue was tied to the gold held in their reserves. A country whose gold holdings fell, had to shrink its money supply too. Such stiff discipline meant inflation was close to zero: governments could not print notes at will. But governments needed huge spending in World War I and so gave up the gold standard for the printing press. Besides, the bulk of gold production came from Russia and South Africa, and others refused to be at the mercy of those two countries for future money supply.

Resort to printing presses started a century of unprecedented inflation. Today, governments cannot contemplate being anchored to gold — that would leave them no flexibility to do things that voters demand. Voters also complain about inflation. But they prefer do-something governments plus inflation to do-nothing governments with stable prices.

The abandonment of the gold standard was not exactly a success. The Great Depression arrived in 1929. Competitive devaluations by different countries caused world trade to sink by almost 80%. So, in 1944, major market economies gathered at Bretton Woods to devise a postwar monetary system. British economist J M Keynes favoured a new international currency, Bancor, anchored in 30 commodities. But there was no political will to give up the printing press. Instead, the new international system was anchored in the dollar, the only currency convertible to gold, with the exchange rates of other currencies overseen by the IMF.

However, the US resented being the only country tied to gold, and gave up that link in 1971. After that, all currencies floated against one another. Countries kept forex reserves mainly in dollars, but also in sterling, yen, and euros.

Recently, the US has ceased to dominate the world economy. It has run up record trade deficits and gargantuan foreign debt. China and other countries hold trillions of dollars in their forex reserves. With Obama printing trillions of dollars to stimulate the US economy, China fears that the dollar — and China’s own re serves — will crash. Hence, Chi na wants SDRs as a rival reserve currency, phasing out the dollar

Others like India are also keen on a fresh issue of SDRs to improve cash availability at a time when global lenders have withdrawn from developing countries. New SDRs could be one more stimulus for the sag ging world economy.

The IMF has since 1970 is sued only 21.4 billion SDRs worth $32 billion at today’s ex change rate. The proposed new issue worth $250 billion will be far larger. Yet, it pales in comparison with trillions of dollars held in forex reserves globally.

SDRs will probably be issued to countries in proportion to their IMF quotas. If so, two-thirds of new SDRs will go to rich devel oped countries. e.g. India will get just 2%, China just 3.7%. Hence, SDRs will hardly dent dollar dominance in global reserves or liquidity.

Many US and German politi cians oppose SDR creation say ing it is ‘‘funny money’’ that will ultimately cause inflation. The Wall Street Journal opposes SDR creation because this will bene fit political foes like Venezuela ($840 million), Iran ($465 mil lion), Sudan ($100 million), Zim babwe ($115 million), Syria ($90 million) and Myanmar ($80 mil lion). Even if Obama persuades US Congress to approve the pro posed $250 billion worth of SDRs, Congress will strongly op pose SDR creation on a scale big enough to rival the dollar as a reserve currency.

Finally, readers should un derstand that the SDR is not a currency at all. It is simply a po tential claim on four national currencies. The SDR is linked to a basket of currencies with a weight of 44% for the dollar, 34% for the euro, and 11% each for the yen and pound sterling.

If any country wants to use its SDRs, it will typically ask the IMF for dollars in exchange. The IMF will debit respective country's SDR account, cred it America’s SDR account, ask the US for the corresponding dol lars, and hand these to the former country.

So, SDRs are anchored in four existing currencies, and do not constitute an independent new currency. Nor will major powers allow the IMF to create a new currency independent of existing ones, anchored perhaps in gold. No politician wants to grant supra-national status to the IMF in money creation. The SDR is allowed in small quanti ties as a derivative of existing currencies. That’s all.

For now, the dollar remains supreme. One day the Chinese yuan may be come fully convertible, and join the list of reserve currencies That may diminish dollar dom inance. But SDRs will remain peripheral.

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