What are Special Drawing Rights?
The IMF created the Special Drawing Rights in 1969.
204 Billion ($285 billion) was created from 1969 to 2016.
Each SDR value is based on the value of five currencies; these are the US Dollar, Pound sterling, Euro, Chinese Renminbi and the Japanese Yen.
SDRs are an international reserve asset used in addition to official reserves.
The International Monetary Fund state that 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”. However, the price of each SDR is priced in US Dollars and each currency in the basket is valued at the conversion rate to the US Dollar. So, basically, it is an asset in the form of a contract that gives a member a claim on another member’s currency within that basket of currencies. Kind of sounds mad and complex doesn’t it, that’s exactly what they want people to think.
Special Drawing Rights could be dubbed as various types of instruments. Some could call them a derivative, possibly an option contract or even actual fiat currency itself. However, SDRs cannot be traded over the markets or purchased from banks or exchanges (not yet anyway), SDR’s are an asset available just for central banks. The IMF does state that they do have the possibility to allocate SDRs to the BIS, ECB and various regional development banks and they can be used in transactions. Coincidence? We think not.
Simply speaking, our view is that SDRs are basically a special currency available for certain types of institutes and economies. SDR’s are literally a contract purchased with a currency that gives claim on another member’s currency. Because it can be transacted then it can be classed as a form of currency and an asset, however it is not legal tender. It is basically a contract purchased with currency that gives a claim on another member’s currency so if a bank holds SDR’s they hold the rights to claim Dollars, euros, renminbi, yuan and the pound sterling and that bank can book that SDR as an asset. One crazy paradox indeed, no not really, just another piece of alchemy presented to us by the lords of finance.
The basket of SDRs consists of the currencies below and how much percentage of the basket each country has been allocated.
WEIGHTED FORMULA AND ALLOCATION: 1 SDR
US DOLLAR – 42%
EURO – 31%
RENMINBI – 11%
YUAN – 8%
POUND STERLING – 8%
: 100% :
These allocations are fixed and are reviewed every five years, the next review is 2021.
A POSSIBLE SCENARIO?
If we were to replay the events of 2008 there are various aspects that we need to look at which can help us understand how the real value of the SDRs comes into play during a crisis. In 2008 global central banks went on a major Quantitative easing program creating trillions in new money ranging from the Dollar, Pound, Euro to the Yuan. TARP, the UK banking rescue, ECB bailout programs and the following quantitative easing that followed were all part of this. These actions created a system consisting of free cheap money available for global banks, which they then used to help the global economy avert itself from a potential depression. Central banks then embarked upon major purchasing sprees pumping hundred’s of billions into the economy via loans, equity purchases and even corporate bond purchases to other forms of monetary stimulus. These QE and bailout programs combined with record low interest rates created an environment where global central banks balance sheets became full up and very vulnerable. Why pay interest on money when you can print money for free right? This is where the value of the Special Drawing Rights resides because the next time a crisis comes, and it will come, central banks cannot print more money without inducing major devaluations of their local currency and triggering a potential hyperinflation period. This is where the SDR’s could come into play because out of all the global central banks the most strongest bank with a strong leverage of 3:1 is the IMF, therefore it has the ability to issue new SDR’s and its balance sheet has the capability to absorb the debt and increase in leverage.
When the next crisis comes, whether it is near or far down the line, the actions that occurred during 2008 will not be available on a global level. Global central banks from the Federal Reserve to the Bank of England to the ECB are all full up and vulnerable and cannot embark on more money printing without causing a potential rapid rise in inflation, hyper-inflation or even a potential run on their currency event. Therefore if we do repeat the events witnessed during 2008 again, due to global banks currently being vulnerable, the only option available will be to layer a whole new currency across the global central banking system. The IMF balance sheet is very strong, the IMF is the lender of last resort and the IMF created and currently holds $285 billion of Special Drawing Rights. So looking in hindsight, the effects of the next crisis could be mitigated via the integration of the Special Drawing Rights. 2008 saw a major period of mergers and takeovers and bailouts of banks induced by the crisis. Merrill Lynch was sold to Bank of America, Northern Rock bankrupt then sold to Virgin money, Bear Stearns sold to J.P Morgan, Lehman Brothers went bust and its assets were sold off to Barclays and other banks. The result of this in the US was the top 10 banks in the controlled over 75% of ALL US banking assets. They were then dubbed as too big to fail.
This is what could possibly happen during the next crisis, global central banks linked to the basket of SDRs could use these SDRs to buffer up their balance sheet and lend more dollars (or currencies) out into the economy. In 2008 central banks saved the banking system, next time, the IMF will most likely save the central banking system who can then mitigate the fallout effects in the global commercial and investment banking system. SDRs could well become a beacon of hope for central banks during the next severe downturn.
The only other option available will be to allow the whole economy to correct itself, if this happens then it will be like 1929, but global. Assets across the board will witness major declines, money will be scarce, debt will cost more, unemployment will shoot up, austerity on steroids will be witnessed and potential social conflict could arise. So in all aspects the two options available will be, let the system crash and correct itself or contain the damage on the system with the implementation of the Special Drawing Rights. Not really great options are they. Time will sure tell.
At least we UK citizens can have a sigh of relief, the pound is the smallest currency within the SDR basket, but hey, at least we are in the basket right. Better in than out we say.
INDICATORS AND SIGNS TO LOOK OUT FOR:
New SDRs created and allocated to members.
Central Banks purchasing SDRs
Media attention towards SDRs