Reprinted from
Europe
and the Evolution of the International
Monetary System
Proceedings of the First Conference
of the International Center
for Monetary and Banking Studies
VANOARY 479
Edited by
Alexander K. Swoboda
Institut Universitaire A. W. Sijthoff
de Hautes Etudes Internationales 1973 Leiden
Genéve
The Expanded Role of SDRs
and the Possibilities of an SDR Standard
Fritz MACHLUP
Princeton University and New York University
The SDR—Special Drawing Rights, issued by the International
Monetary Fund to participating member countries—has really come up in
the financial world. It has been nominated for functions which a couple
of years ago no one had thought it could or should be capable of perform-
ing. The SDR has been proposed as a successor to the present reserve
currencies, particularly to all the dollars now held by national monetary
authorities ; as a successor to gold as the ultimate official reserve asset into
which currencies should be convertible ; and as the common denominator
by which all currencies should be defined or in which their official par
values should be stated. This ambitious career was not foreseen by even
the most friendly of the good fairies that came to present their gifts and
wishes when the SDR was born, let alone by the unfriendly fairies who
predicted a rather dim future for the bastard child. All these fairy wishes
can be found recorded in the minutes of the Annual Meeting of the Inter-
national Monetary Fund held in Rio de Janeiro in September 1967, and
similarly in those of the Meeting held in Washington in September 1969.
My task today is to examine the qualifications of the SDR for the
jobs for which it has been recommended. My own qualifications as an
examiner of the qualifications of SDR are perhaps attested to by my
monographic study published in 1968 under the title Remaking the Inter-
national Monetary System.1 I neither expect nor assume that every one
has read my booklet and, hence, I shall have to repeat a few things—a
very few only—which I wrote there.
THE CHARACTERISTICS OF SDRs
The original intention was that SDRs would be a supplementary
reserve asset, replacing, not existing currency reserves or existing gold
1 Fritz Machlup, Remaking the International Monetary System, Baltimore, The
Johns Hopkins Press, with the Committee for Economic Development, 1968.
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reserves, but increases of currency or gold reserves. It was expected that
there would be no further net increases in monetary gold and that the net
additions of dollars in monetary reserves would decline and soon come
to anend. With these assumptions, only two types of reserves would be
subject to augmentation : one, the countries’ reserve positions with the
Fund through increased drawings made on the basis of quinquennial
increases of quotas and, two, the annual allocations of SDRs.
The essential characteristics of the allocation of SDRs are the fol-
lowing :
— they are gratis reserves in the sense that the countries to which they
are allocated have neither to earn them through surpluses in their
balance of payments nor surrender any assets in exchange for them
nor consider them as debts to be repaid (except in the case of liquida-
tion) ;
— they are not debts, either of the IMF or of anybody else: they are,
therefore, assets of the holder without being liabilities of anybody
(thus resembling in this respect the stocks of monetary gold) ;
— they are, although defined as equivalents of a certain weight of gold,
not convertible into gold or any other assets ;
—- they are not “backed” or “‘covered” by any other asset ;
— they are simply drafts that can be exchanged for convertible currencies
held by countries designated by the Fund, because of their generally
strong reserve position, as possible drawees (recipients of the drafts).
SIGNIFICANCE OF THE PRINCIPLES OF SDR CREATION
My list of particulars or characteristics was offered here not as an
enumeration of defects, though some old-fashioned monetary experts may
think so. To be sure, the non-debt character of the SDR, its non-con-
vertibility, and the lack of cover have all been cited as serious short-
comings, fatal weaknesses, or mortal sins. In contradistinction, I praised
these characteristics as perfectly sensible and most desirable, and I com-
mended the innovating officials for accepting the long overdue break-
through in monetary institutional practice. Let me quote three sentences
from my book : ““Money needs takers, not backers ; the takers accept it,
not because of any backing, but only because they count on others accept-
ing it from them. The myth of backing is dead. It was buried in Rio de
Janeiro on 29 September 1967.’ I must now add some apprehension that
the ghost of the dead myth is still making its midnight rounds and frightens
some of the grown-up children. (It seems especially terrifying to gnomes.)
Most academic economists are amused, not frightened, by the antics
of the ghost. But a good many political economists still dislike the first
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of the characteristics on my list : the gratis allocation of the SDRs. There
are some who regard free gifts to wealthy nations as immoral (even if they
impose no costs on anybody) and would favor such gifts only to poor coun-
tries ; there are others who would prefer the issuance of official reserves
as loans rather than as gifts. I cannot here take the time to repeat my
defense of the principle of gratis allocation to all participating countries ;
but I should not fail to point to the most important advantage of gifts
over loans. If money, international or national, is created by granting
loans, it can also be destroyed by repayments of loans ; when repayments
exceed new borrowings, the stock of money is reduced. (Irving Fisher
Saw in such periodic “debt deflations’” the main cause of the “credit
cycle” with its crises and depressions.) If destruction of monetary
reserves is to be avoided, reserves should not be created by extensions of
repayable loans but, instead, by free allocations.
The reasons for providing for annual increases in total monetary
reserves are as strong as ever. To be sure, countries want reserves in
order to be able to finance deficits in their balance of payments ; but the
creation of new reserves prevents some deficits from occurring and
reduces those that it cannot prevent. Most countries—except those that
have experienced excessive increases in reserves in preceding months and
years—do not want their reserves to decline and they prefer to see them
grow year after year. If total reserves are not growing, the surpluses of
some countries impose deficits on other countries ; attempts to avoid these
deficits take the form of credit restraints, trade restrictions, capital embar-
gos, and exchange controls. The total of surpluses (calculated on the
basis of official reserve transactions) can exceed the total of deficits to the
extent that new reserves are created. Reserve creation, by keeping defi-
cits smaller than they would be without it, serves to reduce the countries’
propensity to restrict international flows of goods, services, and capital.
And this is of eminent importance.
The arguments for annual creation and free allocation of monetary
reserves remain valid even after the dollar flood of 1971; and SDRs are a
most suitable instrument for this purpose.
SDRs AS MAJOR RESERVE ASSET
From the acceptance of the Rio Agreement in September 1967, to the
activation of the SDR facility in January 1970, and indeed even later, not
a few commentators expressed serious doubts that SDRs would ever
become a reserve asset acceptable to national monetary authorities. It
would be tempting to compile a list of the doubting Thomases and the
reasons for their skepticism.
In contrast with these pessimistic views, I foresaw the possibility of a
bright future for SDRs. Although I expected that SDRs in 1970 would
27
be no more than 3 per cent of total reserves, I held that ten years later
SDRs would have attained first place among the official monetary reserve
assets of the world. This now appears to be even more likely, especially if
a large part of existing reserve currencies is to be exchanged into SDRs,
newly issued for this purpose, as proposed by several governors of the
Fund. I am in favor of funding proposals but would prefer to have
existing currency reserves exchanged into IMF deposits. I would, accord-
ingly, anticipate first place among monetary reserves to be attained by the
whole group of IMF issues, including deposits, but not by SDRs alone.
My present view is that SDRs will (or should) share top ranking with
IMF deposits, that reserve currencies will not completely disappear from
official holdings, and that gold will have come from first place to last
place among the reserve assets in a not too distant future. I must now
explain why I want Fund deposits rather than SDRs to be the asset for
which currency reserves should be exchanged.
EXCHANGING EXCESS DOLLAR RESERVES
INTO SDRs OR IMF DEPOSITS
For a good many years proposals have been made to remove cur-
rencies from official monetary reserves. We may recall the plans of
Keynes, Triffin, Maudling, Bernstein and many others, all proposing an
exchange of currencies into other assets, preferably deposit claims against
the Fund. At the annual meeting of the IMF in 1971 several governors
proposed the exchange of official holdings of dollars and sterlings into
SDRs.
I fully share the conviction of these proponents that the excess holding
of dollars and pounds in official reserves should be mopped up through a
large funding operation. We may conceive of several workable techni-
ques by which such funding may be achieved. We might, if time per-
mitted, compare a few of these techniques in greater detail. At this
moment I shall concentrate on arguing against an exchange of excess
currency reserves into SDRs, and in favor of their exchange into deposit
claims against the Fund.
My reasons for this preference are as follows :
— the essential characteristics of SDRs as non-debt assets not covered by
anything should be preserved ;
— the creation of SDRs against surrender of dollars or sterling would
create a claim of the depositor and a debt of the depository ;
— the currencies received by the latter, or the assets into which the cur-
rencies were to be funded, would constitute backing or cover for the
SDRs issued ;
28
— thus the principle of SDR creation would be adulterated and we would
have two kinds of SDRs, some uncovered non-debts, others covered
liabilities of the Fund.
Such an adulteration of the principle of SDRs may put in jeopardy the
important function of the SDR facility as the source of annual increases
of reserves through free allocations to monetary authorities.
The alternative proposal of exchanging dollars into IMF deposits
would have none of these disadvantages. IMF deposits would be a new
type of reserve asset in addition to those now in existence. We need not
fear the operation of Gresham’s Law with respect to the three different
assets issued by the IMF. Still less need we fear that Gresham’s Law
would operate with respect to the increasingly insignificant stocks of
monetary gold. As a matter of fact, it may be desirable to assure the
usefulness of monetary gold by providing for its (voluntary) exchange into
IMF deposits. (If the price of gold in the free market should appreciably
increase, it might be decided that the Fund eventually begin selling its
gold—in small instalments—at a profit, which can be used for additional
financing of development aid.)
MAKING SDRs THE COMMON DENOMINATOR
FOR PAR VALUES OF CURRENCIES
Several governors of the Fund have discussed the possibility of using
the unit of SDR as a common denominator for stating the par values of
currencies. In view of the fact that SDRs are now defined in weights of
gold, the proposal seems to make little practical difference. None the
less, monetary authorities may wish to continue the “phasing out’’ of gold
by replacing it also in the function of common denominator in fixing par
values of their currencies.
Difficulties of definition may tax the imagination of lawyers. For the
economist no such difficulty exists: in the mode of Gertrude Stein, “‘a
unit is a unit is a unit’—and the unit may be a pure abstraction. Thus
there would be no problem in expressing all par values in terms of a Fund
unit. It would be awkward to call it SDR, since also the general account
of the IMF and the deposit claims against the IMF should all be denomi-
nated in the same units. “Fondor” strikes me as a good name for the
unit.
The hope has been expressed that the replacement of gold by SDRs as
common denominator for par values would provide more symmetry in the
positions of different currencies and do away with the special position of
the dollar. The dollar could then be devalued or upvalued in terms of
SDR or Fund units like any other currency. Alas, this is a fallacy. The
29
lack of symmetry is not a question of the choice of denominator but is due
to several facts of our financial life. The most pertinent of these are, one,
that the dollar is the most convenient international transactions currency
and, two, that the dollar is generally used as official intervention currency.
As long as monetary authorities intervene in the foreign-exchange markets
by selling and buying dollars, the dollar remains in an asymmetrical
position.
This position is essentially the logical corollary of the fact that there
can be only n-1 exchange rates for n currencies. If n-1 countries inter-
vene in dollars at rates which they themselves determine, the United States
can neither raise nor lower the external exchange value of the dollar. The
United States can devalue or revalue the dollar only with the cooperation
of the other countries. A set of rules with sanctions will have to be
developed to enforce the necessary cooperation.
One may argue that all other countries would respect any change in
par value (in terms of SDR, gold, or anything else) announced for the
dollar by the United States, and would always adjust their intervention
rates to conform with that announcement. If they did, they would be
obeying a “rule” in a system of perfect cooperation. But would they ?
Would Japan or France have accepted a devaluation of the dollar if the
United States had “announced” it on 15 August 1971? Surely not.
Alternatively, one may reject the view that the United States must
passively accept the pattern of exchange rates which other countries
determine by their interventions in the foreign-exchange markets. If the
United States finds any of these rates seriously undervalued in relation to
the dollar, it could start intervening, buying the currency in question at a
higher price. Since such an exchange-rate war would lead to unlimited
profits for arbitrageurs and perpetual inflationary money creation in the
warring countries, an economically weaker country would have to capi-
tulate sooner or later and accept the devaluation of the dollar. Thus, the
denial of the need for international cooperation turns out to be in fact a
confirmation of the thesis that cooperation may have to be imposed on
those who want to go on imposing an overvaluation of the dollar on a
“benign” United States.
An interesting suggestion in this connection has recently been made
by Professor John Williamson. ° If the United States wanted to reduce
or remove an enduring payments deficit by devaluing its overvalued dollar,
but other countries insisted on perpetuating the overvaluation of the dol-
lar by declaring parallel devaluations of their currencies (in terms of gold
or SDRs) and thus continued to purchase dollars at unchanged exchange
2 John Williamson, The Choice of a Pivot for Parities, Essays in International
Finance, No. 90, Princeton, International Finance Section, November 1971.
30
rates—too high for restoring balance—the Fund should issue sufficient
amounts of SDRs to enable the United States to buy back the dollars
being accumulated by surplus countries. These issues of SDRs would
make it possible for other countries to go on having their surpluses and
for the United States to remove its deficit. (The deficit would be
“removed” if the allocation of SDRs is entered above the line in the
balance of payments ; it would be “‘financed”’ if the receipt of the SDRs is
entered below the line.) When other countries eventually get tired of
exchanging their goods, services, and securities for ever increasing piles
of SDRs, they may decide to accept a devaluation of the dollar.
An interesting aspect of Williamson’s suggestion is that more SDRs
are to be issued when more dollars flow into foreign reserves. This is in
sharp contrast to the recommendations of other experts, who would issue
less SDRs when more dollars swell the reserves of other countries.
MAKING SDRs THE OBJECT OF CONVERTIBILITY
OF OTHER RESERVE ASSETS
At present the dollar is inconvertible. No matter how much some of
the monetary authorities press for resumption of convertibility, the dollar
must remain inconvertible as long as the vast mass of dollars is held by
other monetary authorities. There cannot even be an approach to con-
vertibility until the existing dollar holdings have been funded, mopped up
or locked in ; perhaps provisional arrangements can be made for condi-
tional convertibility or exchange-value guarantees limited to dollars
acquired after 18 December 1971 (or an even later date). The only
reason for such interim arrangements would be to encourage the mone-
tary authorities of the financially most important countries to declare that
they would defend the new floor price of the dollar no matter how many
dollars were offered to them. Such a declaration would inspire private
holders of dollars with sufficient confidence to hold on to their dollar
balances and not to be panicked into a renewed flight from the dollar.
(Incidentally, if the countries had agreed to a system of limited adjust-
ments of central rates or par values—‘“‘crawling pegs’’—the new pattern
would have been more credible than the presumably fixed parities with a
fixed floor only 2 1/4 per cent below these parities.)
Long-term arrangements for convertibility can become effective only
after the great mopping-up and locking-in of the excess holdings of dol-
lars (acquired before 15 August or 18 December 1971) have been com-
pleted. Mopping-up would be preferable to locking-in, at least from the
point of view of the dollar-holding national authorities. Blocked or
locked-in currency reserves can hardly be considered liquid monetary
assets, unless special arrangements secure their transferability to other
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countries when their present holders are in deficit positions. In any case,
the exchange of official excess holdings of dollars into Fund deposits
denominated in Fund units would be more appropriate from the point of
view of international liquidity.
When the official excess holdings of dollars are out of the way, dollars
newly acquired by national monetary authorities can be made convertible
into SDRs (or also into reserve positions with the Fund and deposits with
the Fund). The new convertibility may still raise problems with regard
to the large dollar balances held by private foreigners. These are now
estimated to run to about $18 billion, with their “normal” size estimated
to be about $25 billion at the present volume of international transactions.
Can the United States reasonably undertake an obligation to convert offi-
cial holdings of dollars into SDRs (or into claims against the Fund), if
large amounts of privately held dollars may come onto the market at the
slightest provocation—crises of confidence—and may have to be absorbed
by monetary authorities, which in turn will present them for conversion ?
I would answer this question affirmatively only if the new international
monetary system provides for greater flexibility of both interest rates and
exchange rates.
A large speculative outflow of funds from the United States and
excess supply of dollars in the foreign-exchange markets can be stemmed
if interest rates for dollars rise sufficiently above those for other currencies
and if the exchange rate for the dollar can fall sufficiently to make people
anticipate a strong recovery of the dollar in subsequent months. A band
of only 4 1/2 per cent, that is, 2 1/4 per cent up or down from the center,
is probably not enough for this purpose. I stick to my recommendation
of a band of 5 or 6 per cent, that is, 2 1/2 or 3 per cent around a center
(parity) that can glide up or down with maximum changes of 1 per cent
at a time and 2 or 3 per cent cumulatively over any twelve-month period.
These speed limits for changes in parities and exchange rates can reduce
the threat of speculative movements of liquid funds and can facilitate the
adjustments to divergent trends in structural and monetary developments
in different countries.
THE COEXISTENCE
OF CONVERTIBILITY AND FLEXIBILITY
If limited flexibility of exchange rates is necessary for the promise of
convertibility to be honest and credible, why, one may ask, is convertibility
needed at all? If the exchange rate of the dollar is flexible, will mone-
tary authorities be willing to acquire dollars in any large amounts ? How
can one expect a central bank to acquire large amounts of dollars at or
near an agreed par of exchange if the rate at which the dollars can be
32
converted into SDRs may be reduced before the dollars can be presented
to the United States ?
The answers to these questions presuppose comprehension of the fact
that “limited flexibility” may mean greater stability of exchange rates than
that which exists under “fixed parities”. Fixed parities are adjusted from
one day to another by as much as 8, 12, or 16 per cent, and even more.
In contrast to these jumping parities, gliding parities (or “crawling pegs’’)
under a system of limited flexibility can be changed by only one per cent
at a time, and by only 2 or 3 per cent over a year. Hence, if the rule is
obeyed, the risk of acquiring and holding dollars is smaller under a sys-
tem of greater flexibility than under one of rigidity of par values ; and
convertibility is more easily maintained than with allegedly fixed parities.
I realize, of course, that convertibility (into SDRs or any other kind
of reserve asset) would make no sense under a system of freely flexible
exchange rates. Such a system would have no par values, no interven-
tions in the foreign-exchange markets, no official acquisitions of dollars
or any other foreign currencies and, hence, no conversions of currencies
acquired. But we are not talking now about a system of freely flexible
rates, because we all realize that such a system will not exist in the fore-
seeable future. We are talking about managed, limited flexibility. Such
a system will include official interventions, official acquisitions of dollars,
and hence, arrangements for converting dollars so acquired into other
reserve assets (such as SDRs). The only alternatives to convertibility of
this kind would be guarantees for the maintenance of the exchange value
or purchasing power of the dollars acquired and held by the authorities
of foreign countries.
THE “SDR STANDARD”
In the title of my paper appear the words “possibilities of an SDR
standard”. I have not used this expression up to now. I have avoided
‘t because it has no clear meaning. I now want to expose the ambiguity
of the phrase.
Adoption of the “SDR standard” may mean any of the following
things :
(1) The SDR, or a unit of SDR, is the standard of value in which the
people—businessmen, government officials, and perhaps also house-
holds—in the countries that have adopted that system calculate and
compare the exchange values of goods and services.
(2) The SDR is the unit of account in which, in international transactions,
prices, claims, debts, and payments are expressed.
(3) The SDR is the common denominator for stating, fixing, and refixing
the par values of different currencies.
33
(4) SDRs are the most important asset held in the monetary reserves of
the financially most important countries.
(5) SDRs are the reserve asset into which currencies are convertible under
rules adopted by the major countries.
(6) The amounts of SDRs held as reserve by the monetary authority of a
country determine the supply of its national money, or the increase
in its SDR reserve determines the increase in its money supply.
Meaning (1) may be rejected out of hand (because it is inconceivable
that the SDR will become the general standard of value). Meaning (6)
may be excluded as too unlikely ever to become relevant. This leaves
four possible meanings : the SDR may serve as the international unit of
account, as the common denominator for setting par values, as the most
important reserve asset, and as the asset into which currencies are made
convertible. These four functions are independent of one another ; any
one can possibly be performed without any of the others. Hence, the
expression “SDR standard’ would always require specification of the
meaning in which it is used, and this would take more time than to state
the function or functions which the SDR is really supposed to serve.
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