A new IMF reserve currency without the problems of the substitution account – The creation of Special Transaction Rights

Martin Skala 20 April 2011

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In the wake of the global financial crisis, the discontent with the current international monetary system lingers on (see for example Vines 2010). But is there an alternative given the decades-old discussions about gold, Bretton Woods Systems, Bancor, and Special Drawing Rights (SDRs)? Yes, there is.

In this column I outline a proposal for the creation of Special Transaction Rights. Special Transaction Rights (STRs) would circumvent the problems of the substitution account associated with SDRs (and the Triffin dilemma), and they would also foster reserve diversification and the build up of local bond markets. 

STRs are special rights for sovereigns to undertake a foreign-exchange reserve transaction with the IMF and to receive a new reserve medium, meant to allow for an orderly reserve diversification. These transactions are recorded in a special transaction account managed by the IMF. While the asset side lists the incoming reserve currencies (e.g. dollar and euro), the liability side records the STRs handed out. The STR is a currency basket like the SDR, but much broader. While the SDR basket consists currently of four “freely usable currencies”, the STR could take in far more currencies from advanced countries and emerging markets alike. The coverage of all G10 and G20 countries plus some more is envisaged. Hence, with the STR a universal reserve medium could be created. 

The main criteria for inclusion would be a reasonable secure investment possibility in the country of origin, i.e. in the local bond market. The weights of the different components could reflect GDPs and market volumes of reasonable secure investment possibilities. The STR comes with an interest rate which is the weighted average of the reference interest rates of the individual currencies in question (possibly with a tiny discount to cover for debt restructurings). Further, STRs are different from present SDRs as they are not meant as rights to draw on (mainly) other countries’ currencies to get means of payments, but are primarily meant to be a reserve portfolio tool. 

The IMF would decide, say with supermajority, on the total sum of STRs to be allotted; this could also be indexed to allow for a yearly increase, in case the STRs are set at a percentage (e.g. 10, 20 or 30%) of the total reserves of IMF members. Second, the STRs are allocated to all IMF members according to a key; this could be for example the respective quota shares at the IMF. But as the STRs are especially designed for reserve-acquiring emerging markets, the key could well be just the country’s shares in global reserves. Third, the countries may or may not exercise their rights and transact normal foreign-exchange reserves against STRs, up to the individual allocated amount.

The STR is meant to be 100% backed fiat reserve money created by the IMF. Hence, a reversed transaction with the IMF is not envisaged, i.e. an exchange-rate risk does not exist. However, IMF members are free to buy and sell their STRs among each other for and against wanted currencies at bilaterally agreed prices, allowing for subsequent reserve portfolio alterations or for the acquisition of means of payments, if needed. In this way, STRs can be exchanged back to “real” money for non-sovereigns, but chances and risks are covered by the respective counterparts only. It can be expected that the exchange rate of the STR vis-à-vis individual currencies will be rather stable, given that the basket includes even more currencies than the SDR.

On the asset side of the special transaction account, the IMF would accept all means of reserves, regardless of the currency or the maturity. However, given the current foreign-exchange reserve composition, short-run US Treasury bills are likely to dominate. An interest-rate risk exists whenever the interest rate received is less than the corresponding interest rate to be paid for STRs. To eliminate this risk as much as possible, the compositions of the asset and the liability side should be as similar as possible. In other words, whenever a foreign-exchange reserve asset matures, it is reinvested by the IMF according to the underlying key of the STR basket. Hence, the STR composition should also reflect the preferences of global reserve diversification by IMF members. However, the weights need to also reflect the depth in the respective markets. In the presence of an obstacle – for example the fear that unwanted exchange rate movements would arise – then the shift in composition of the asset side could be delayed.

The IMF-led foreign-exchange reserve management would therefore involve transforming the asset side of the special transaction account over time so that it would resemble the basket components of the liability side. Once this is achieved, the interest rate risk would cease to exist. In case a currency is currently not used as an actual foreign-exchange reserve, say the Brazilian real, but is included in the basket, the IMF’s task would be to introduce the currency on the asset side of the special transaction account.

The advantages of the Special Transaction Rights are plentiful:

  • First, it would be a very easy mean of reserve diversification, which would be an average interest bearing instrument of the world economy.
  • Second, the diversification – primarily away from the dollar – would be not done unilaterally by an individual country, but by the IMF in a coordinated approach taking the stability of the international monetary system into due consideration.
  • Third, this diversification away from the dollar could not be interpreted as a tactical manoeuvre, insider trading within the central bank community or a hostile act by individual actors. In addition, this would also better reflect the multi-polarity of present day world economy.
  • Fourth, the IMF could help especially emerging markets in their effort to build-up their own, open and deeper bond markets.
  • Fifth, this would all in all reflect better interconnectedness, interdependence and ownership of the well-being of the international monetary system.
  • Sixth, to further minimise consequences for the system of the exchange rate, the total amount of allocated STRs could be phased in slowly from year to year.
  • Last but not least, further features could be imagined, like an anchor function to other fixed currencies or a factoring function for commodities.

References

Vines, David (2010), “European financial vulnerability and the need for a rules-based international monetary system”, VoxEU.org, 4 June.

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Topics:  Global crisis International finance International trade

Tags:  IMF, Special drawing rights, International Monetary System, Special Transaction Rights, Bretton Woods

Martin Skala

Professor of Economics, FOM University

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