Greece repays IMF using the IMF’s own “currency”

Greece this week repaid €750m to the International Monetary Fund (IMF) which it funded by drawing on its SDR account at the IMF. This legitimate but unusual move caught many commentators by surprise and drew attention to the little known SDR.

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The SDR – Special Drawing Right – is something of a curiosity in international finance, barely mentioned in finance courses and very obscure to the general public. Greece’s use of their SDR holdings to pay an actual bill showed they can be useful. So what are they and where do they come from?

Creation of the SDR to help international liquidity

Back in the 1960s the dollar was even more widely used than now as the means of international trade payment. Imagine Greece wanted to buy some imports from India, with neither country being very willing to hold the other’s currency. They would settle in US dollars. But for that to happen Greece would need to get the dollars from somewhere. All dollars, whether in physical cash form or in bank accounts, come from the US. So the only way for another country to get dollars is to run a current account surplus with the US. For a while in the early 1960s the US was running small balance of payments deficits which therefore limited the amount of dollars the rest of the world could get hold of. So the supply of dollars failed to keep up with the rapid growth in world trade. There was no realistic alternative (just like today) to using the dollar, so there was a risk that trade would be constrained by the dollar shortage.

The solution was to create a new form of internationally accepted means of payment, issued by the IMF. This might look very much like a new global central bank issuing a new currency and that was what was originally intended. But the US, while accepting the need for new international liquidity, was opposed to a new currency. So the new instrument was given the cumbersome name Special Drawing Right. All IMF members have an automatic entitlement to an amount of SDRs, in relation to their membership share, which was loosely related to their relative GDP share of the world economy as it was in the late 1940s when the IMF got going. SDRs could be used only for official transactions, namely between government entities such as central banks. It was of limited use in trade therefore but would allow a central bank to use more of its currency reserves to fund trade while retaining SDRs as another form of reserves.

The slow process of creating SDRs and the US reluctance to let them appear too much like a real currency meant that by the time they were issued in 1969 they were no longer needed. The US was by then running large balance of payments deficits owing to the rapid growth of government spending for the Vietnam War and for domestic spending to reduce poverty and improve social welfare. The shortage of dollars had turned into an excess, leading to the ending of dollar convertibility into gold and the collapse of the fixed exchange rate system in 1971. So the SDRs have sat there, largely unused ever since.

The SDR’s value was originally defined as equivalent to 0.888671 grams of fine gold—which, at the time, was also equivalent to one U.S. dollar. Since the end of the fixed exchange rate regime in 1971, the SDR’s value is defined relative to a basket of leading currencies. It is also used as a reference exchange rate in IMF transactions, though that could be done without the SDR actually existing as an asset, it could be just an index. After the financial crisis the IMF in 2009 increased the SDR total in existence to SDR204 billion, which is about $287 billion (SDR1 = $1.41 at present). That is a drop in the ocean of global foreign exchange reserves, which total about $12 trillion (thousand billion). The IMF estimates that about 62% of reserves are held in US dollars.

The basis of a future global currency?

Everybody had more or less forgotten about SDRs until the world financial crisis of 2008-09. The newly revealed fragility of the US financial system and the then large US budget deficit (which has since shrunk dramatically) made many people wonder whether it would be a good idea to create a new global currency. The governor of the People’s Bank of China (China’s central bank), Zhou Xiaochuan, suggested in 2009 that the SDR might form the basis of a new global currency. The idea remains valid but currently it’s unlikely that the US or China would wish to create a new rival to their currencies. As the Eurozone mess has shown, a credible central bank needs to be powerful and independent of governments. The Fed faces a lot of criticism from the US Congress about its supposedly excessive power and it’s quite incredible that US politicians would support a new global central bank any time soon. The Chinese government is used to being in control of the financial system and, at a time when the RMB is gradually becoming more widely used internationally, a new global currency would not be popular.

SDRs: a curious type of financial asset

The definition of a financial asset is an asset with a counterpart liability. A real asset by contrast has no such counterpart. Imagine a bond, share or banknote. All are claims on somebody else, either a company, a government or a central bank. A real asset such as a car, house or patent has no counterparty, it has value because of its potential flow of benefits directly to the owner.

But there are two exceptions to this rule. One is monetary gold. Gold can be a real asset when its used as jewelry or in electronics. But it can also be held as a financial asset, even though it is not a claim on anybody else. Its value is entirely based on the possibility of selling it to somebody else in future (or in reverting to its much lower value as a real asset). So gold’s vaelue is entirely about confidence in other people’s view of it as valuable, the ultimate ponzi asset.

The other exception is the SDR. Unlike a currency, which is a liability of the central bank issuing it, the SDR is legally NOT a liability of the IMF. The US insisted on this in part to make sure that it couldn’t gradually turn into a new currency, threatening to replace the dollar.

So the Greek government has used some of its entitlement to SDRs to pay a debt owed to the IMF, which issued them. This appears circular and rather dubious but it is technically sound. Whether it will make any difference to Greece’s ultimate ability to avoid default on the rest of its debt remains to be seen.

Further reading

IMF factsheet on the SDR:

Previous blogs on the IMF: The once and future king? The IMF; Slow progress in reforming the IMF; The revival of the IMF