SDRs Explained

4 04 2009

From Krugman:

S.D.R.’s, or special drawing rights, in which the International Monetary Fund keeps its accounts.

But there’s both less and more here than meets the eye. S.D.R.’s aren’t real money. They’re accounting units whose value is set by a basket of dollars, euros, Japanese yen and British pounds. And there’s nothing to keep China from diversifying its reserves away from the dollar, indeed from holding a reserve basket matching the composition of the S.D.R.’s — nothing, that is, except for the fact that China now owns so many dollars that it can’t sell them off without driving the dollar down and triggering the very capital loss its leaders fear.

Some background and further explanation from Foreign Policy’s Annie Lowrey:

Back in 1969, the world economy was still suffering from the effects of the Great Depression and the world wars. At the Bretton Woods conference at the end of World War II, the heads of state attending decided against creating a global reserve currency, instead instituting a fixed-rate exchange system.

Twenty-five years later, there weren’t enough key exchange assets — units of gold bullion and dollars — to keep up with the growing global economy. So, the IMF’s member states decided to create the SDR system.

A basket of stable major currencies — like the dollar, pound, and yen — determined its value. Some countries, like Latvia, pegged their currencies to the value of the SDR. But most just used their allocated portion in various international transactions.

But, just a few years after the IMF bothered to make the SDRs, the Bretton Woods fixed-rate system collapsed and the modern world currency market, where exchange rates float freely, emerged. This rendered the SDRs pretty much useless.

Indeed, the current market for SDRs, until the I.M.F. injection, was just $32 billion. The value of current oustanding U.S. currency? Just over $1 trillion.

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