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Archive for May 7th, 2010

IMF fact sheet on SDRs

Posted by WARREN MOSLER on 7th May 2010


Special Drawing Rights (SDRs)

January 31, 2010

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August 28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion to SDR 204.1 billion (equivalent to about $ 321 billion).

The role of the SDR

The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. A country participating in this system needed official reserves—government or central bank holdings of gold and widely accepted foreign currencies—that could be used to purchase the domestic currency in foreign exchange markets, as required to maintain its exchange rate. But the international supply of two key reserve assets—gold and the U.S. dollar—proved inadequate for supporting the expansion of world trade and financial development that was taking place. Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF.

However, only a few years later, the Bretton Woods system collapsed and the major currencies shifted to a floating exchange rate regime. In addition, the growth in international capital markets facilitated borrowing by creditworthy governments. Both of these developments lessened the need for SDRs.

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. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR, serves as the unit of account of the IMF and some other international organizations.

Basket of currencies determines the value of the SDR

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973, however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen, pound sterling, and U.S. dollar. The U.S. dollar-value of the SDR is posted daily on the IMF’s website. It is calculated as the sum of specific amounts of the four currencies valued in U.S. dollars, on the basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive Board to ensure that it reflects the relative importance of currencies in the world’s trading and financial systems. In the most recent review (in November 2005), the weights of the currencies in the SDR basket were revised based on the value of the exports of goods and services and the amount of reserves denominated in the respective currencies which were held by other members of the IMF. These changes became effective on January 1, 2006. The next review will take place in late 2010.

The SDR interest rate

The SDR interest rate provides the basis for calculating the interest charged to members on regular (non-concessional) IMF loans, the interest paid and charged to members on their SDR holdings and charged on their SDR allocations, and the interest paid to members on a portion of their quota subscriptions. The SDR interest rate is determined weekly and is based on a weighted average of representative interest rates on short-term debt in the money markets of the SDR basket currencies.

SDR allocations to IMF members

Under its Articles of Agreement, the IMF may allocate SDRs to members in proportion to their IMF quotas. Such an allocation provides each member with a costless asset. However, if a member’s SDR holdings rise above its allocation, it earns interest on the excess; conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall.
There are two kinds of allocations:

General allocations of SDRs. General allocations have to be based on a long-term global need to supplement existing reserve assets. Decisions to allocate SDRs have been made three times. The first allocation was for a total amount of SDR 9.3 billion, distributed in 1970-72 in yearly installments. The second allocation, for SDR 12.1 billion, was distributed in 1979–81 in yearly installments.

The third general allocation was approved on August 7, 2009 for an amount of SDR 161.2 billion and took place on August 28, 2009. The allocation increased simultaneously members’ SDR holdings and their cumulative SDR allocations by about 74.13 percent of their quota.

Special allocations of SDRs. A proposal for a special one-time allocation of SDRs was approved by the IMF’s Board of Governors in September 1997 through the proposed Fourth Amendment of the Articles of Agreement. Its intent is to enable all members of the IMF to participate in the SDR system on an equitable basis and correct for the fact that countries that joined the Fund after 1981—more than one-fifth of the current IMF membership—had never received an SDR allocation.

The Fourth Amendment became effective for all members on August 10, 2009 when the Fund certified that at least three-fifths of the IMF membership (112 members) with 85 percent of the total voting power accepted it. On August 5, 2009, the United States joined 133 other members in supporting the Amendment. The special allocation was implemented on September 9, 2009. It increased members’ cumulative SDR allocations by SDR 21.5 billion using a common benchmark ratio as described in the amendment.

Buying and selling SDRs

IMF members often need to buy SDRs to discharge obligations to the IMF, or they may wish to sell SDRs in order to adjust the composition of their reserves. The IMF acts as an intermediary between members and prescribed holders to ensure that SDRs can be exchanged for freely usable currencies. For more than two decades, the SDR market has functioned through voluntary trading arrangements. Under these arrangements a number of members and one prescribed holder have volunteered to buy or sell SDRs within limits defined by their respective arrangements. Following the 2009 SDR allocations, the number and size of the voluntary arrangements has been expanded to ensure continued liquidity of the voluntary SDR market.

In the event that there is insufficient capacity under the voluntary trading arrangements, the Fund can activate the designation mechanism. Under this mechanism, members with sufficiently strong external positions are designated by the Fund to buy SDRs with freely usable currencies up to certain amounts from members with weak external positions. This arrangement serves as a backstop to guarantee the liquidity and the reserve asset character of the SDR.

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corrected post on IMF operations

Posted by WARREN MOSLER on 7th May 2010

I now understand it this way:

The IMF creates and allocates new SDR’s to its members.

There is no other source of SDR’s.

SDR’s exist only in accounts on the IMF’s books.

SDR’s have value only because there is an informal agreement between members that they will use their own currency to lend against or buy SDR’s from members the IMF deems in need of funding who also accept IMF terms and conditions.

Originally, in the fixed exchange rate system of that time, this was to help members with balance of payments deficits obtain foreign exchange to buy their own currencies to keep them from devaluation.

The system failed and now the exchange rates are floating.

Currently SDR’s and the IMF are used by members needing help with foreign currency funding needs.

Looks to me like Greece will be borrowing euro from other euro nations using its SDR’s as collateral or selling them to other euro nations.

Either way it’s functionally getting funding from the other euro members.

Greece is also accepting IMF terms and conditions.

The only way the US is involved is if a member attempts to use its SDR’s to obtain $US.

The US is bound only by this informal agreement to accept SDR’s as collateral for $US loans, or to buy SDR for $US.

SDR’s have no intrinsic value and are not accepted for tax payments.

It’s a lot like the regional ‘currencies’ like ‘lets’ and ‘Ithaca dollars’ that are also purely voluntary and facilitate unsecured lending of goods and services with no enforcement in the case of default.

It’s a purely voluntary arrangement which renders all funding as functionally unsecured.

There is no IMF balance sheet involved.

While conceptually/descriptively different than what I erroneously described in my previous post, it is all functionally the same- unsecured lending to Greece by the other euro nations with IMF terms and conditions.

The actual flow of funds and inherent risk is as I previously described.

No dollars leave the Fed, euro are transferred from euro members to Greece.

I apologize for the prior incorrect descriptive information and appreciate any further information anyone might have regarding the actual current arrangements.

Prior post:

I understand it this way:

The US buys SDR’s in dollars.
those dollars exist as deposits in the IMF’s account at the Fed.

The euro members buy SDR’s in euro.
Those euro sit in the IMF’s account at the ECB

The IMF then lends those euro to Greece
They get transferred by the ECB to the Bank of Greece’s account at the ECB.

The IMF’s dollars stay in the IMF’s account at the Fed.

They can only be transferred to another account at the Fed by the Fed.

U.S. taxpayers are helping finance Greek bailout

By Senator Jim DeMint

May 6 — The International Monetary Fund board has approved a $40 billion bailout for Greece, almost one year after the Senate rejected my amendment to prohibit the IMF from using U.S. taxpayer money to bailout foreign countries.

Congress didn‚t learn their lesson after the $700 billion failed bank bailout and let world leaders shake down U.S taxpayers for international bailout money at the G-20 conference in April 2009. G-20 Finance Ministers and Central Bank Governors asked the United States, the IMF‚s largest contributor, for a whopping $108 billion to rescue bankers around the world and the Obama Administration quickly obliged.
Rather than pass it as stand-alone legislation, President Obama asked Congress to fold the $108 billion into a war-spending bill to send money to our troops.

It was clear such an approach would simply repeat the expensive mistake of the failed Wall Street bailouts with banks in other nations. Think of it as an international TARP plan, another massive rescue package rushed through with little planning or debate. That‚s why I objected and offered an amendment to take it out of the war bill. But the Democrat Senate voted to keep the IMF bailout in the war spending bill. 64 senators voted for the bailout, 30 senators voted against it.

Only one year later, the IMF is sending nearly $40 billion to bailout Greece, the biggest bailout the IMF has ever enacted.

Right now, 17 percent of the IMF funding pool that the $40 billion bailout is being drawn from comes from U.S. taxpayers. If that ratio holds true, that means American taxpayers are paying for $6.8 billion of the Greek bailout. Although the $108 billion extra that Congress approved for the IMF in 2009 hasn‚t yet gone into effect, you can bet that once it does Greek bankers will come to the IMF again with their hat in hand. And, if other European Union countries see free money up for grabs they could ask the IMF for bailouts when they get into trouble, too. If we‚ve learned anything from the Wall Street bailouts it‚s that just one bailout is never enough.
To hide the bailout from Americans already angry with the $700 billion bank bailout, Congress classified it as an „expanded credit line.‰ The Congressional Budget Office only scored it as $5 billion because IMF agreed to give the United States a promissory note for the rest of the bill.
As the Wall Street Journal wrote at the time, „If it costs so little, why not make it $200 billion. Or a trillion? It‚s free!‰

Of course, money isn‚t free and there are member nations of the IMF that won‚t be in a hurry to pay it back. Three state sponsors of terrorism, Iran, Syria and Sudan, are a part of the IMF. Iran participates in the IMF‚s day-to-day activities as a member of its executive board.

If the failed bank bailout and stimulus bill wasn‚t enough to prove to Americans the kind of misguided, destructive spending that goes on in Washington this will: The Democrat Congress, aided by a few Republicans, used a war spending bill to send bailout money to an international fund that‚s partially-controlled by our enemies.

America can‚t afford to bail out foreign countries with borrowed dollars from China and certainly shouldn‚t allow state sponsors of terror a hand in that process.

This has to stop if we are going to survive as a nation. Congress won‚t act stop such foolishness on its own. The only way Americans can stop this is by sending new people to Washington in November who will.

Sen. Jim DeMint is a Republican U.S. Senator from South Carolina.

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