Last rites for the dollar are premature.

• Author: Aiyar, Swaminathan S. Anklesaria
• Position: Economics

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"If the U.S., EU, and Japan agreed to guarantee a new [International Monetary Fund] currency, it theoretically could come into existence, but there is not the slightest prospect that hard-currency countries will do so."

TO HELP ALLEVIATE the global recession, the Group of 20, at its meeting in April in Great Britain, decided, as part of an overall stimulus plan of one trillion dollars. on a fresh allocation of $250.-000.000.000 worth of Special Drawing Rights by the International Monetary Fund to its member states. This immediately raised public interest in the question of whether SDR will evolve into a new international currency that supplements, and eventually rivals, the dollar. A subsequent G-20 meeting in September in the U.S. (Piusburgh) did little to quell the matter. Many politicians and economists want an enhanced role for SDRs in foreign exchange reserves. However, SDR is not a currency, and never will be, because countries that matter never shall bestow money-creating power on the IMF.

Currently, SDR plays two roles. First, it is a unit of account. Its value is defined as the value of a weighted basket of four currencies. The SDR basket has weights of 44% for the U.S. dollar, 34% for the euro, and 11% each for the yen and pound sterling. It is a derivative of four national currencies; a derivative is not a currency. Transactions, loans, and contracts usually are designated in a single currency, like the dollar, but they can be designated in SDRs, so that the currency risk of the contract is diversified among four currencies.

The second role of SDR is as a mutual line of credit for members of the IMF, which so far has allocated a total of 21,300,000,000 SDRs to its members in proportion to their shareholding. The IMF acts as a middleman for credit lines from SDR-surplus to SDR-deficit countries. The credit and debit balances carry interest, at rates linked to rich-country bonds. Debtor nations normally would pay much higher rates, so the SDR line of credit can be viewed from the borrower's viewpoint as being subsidized, although it is not explicitly subsidized by the lender. SDR allocations add to the purchasing power of needy IMF members, who view it as especially valuable since it is not subject to the conditionalities of normal IMF loans--but clearly this limited role of the SDR, providing modest quantities of unconditional financial assistance, does not make it a new currency.

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Many countries and economists feel that the existing system of international reserves has deep flaws, and that remedies might include a substantially expanded role for the IMF and SDRs. To understand these new reforms, a brief history of the evolution of reserve currencies and of SDR is helpful.

The gold standard

Before World War I, most countries were on the gold standard: their currency issue was tied to the gold held in their reserves. A nation whose gold holdings fell had to shrink its money supply, too. Such stiff discipline meant that inflation was close to zero--a clear benefit. Yet, the gold standard deprived countries of the monetary flexibility to combat adverse conditions: they could not print currency to meet politically urgent expenses. The abandonment of the gold standard after World War I may have given governments flexibility, but certainly did not guarantee economic stability or success. The Roaring Twenties were followed by the Great Depression in 1929, which created a decade of misery until it was ended by the demands of war...