A New SDR Allocation

On March 23, the Managing Director of the International Monetary Fund, Kristalina Georgieva, reported that: “I am very encouraged by initial discussions on a possible SDR allocation of US$650 billion. By addressing the long-term global need for reserve assets, a new SDR allocation would benefit all our member countries and support the global recovery from the COVID-19 crisis.” “IMF Executive Directors discuss new SDR allocation” The SDR is the international reserve asset and unit of account created and issued by the IMF to supplement the U.S. dollar in those roles. There are important advantages to replacing or reducing the dominance of the U.S. dollar in global commerce with an internationally issued currency with a more stable value than the dollar or any other single currency. “Returning to currencies with hard anchors” Real SDR Currency Board

The IMF’s Articles of Agreement require a long-term global need for additional reserves to justify an allocation. Thus, the Managing Directors call for a new allocation is “based on an assessment of IMF member countries’ long-term global reserve needs, and consistent with the Articles of Agreement and the IMF’s mandate.”  “IMF Executive Directors discuss new SDR allocation”  While I think an allocation is justified and useful at this time, the underlying motivation of aiding IMF members to fight the economic impact of the Covid-19 pandemic is unfortunate.

The aid motivation is revealed in a Wall Street Journal editorial on March 24, 2021, which unfortunately misrepresents important features of the SDR. “Special dollars for dictators”

Setting aside for a minute that I have long proposed replacing the SDR allocation system described in this article with issuing SDR under currency board rules (i.e., only and to the extent demanded by the market and purchased by the market at market prices), there are a lot of mistakes in this article. Allocated SDRs are in effect a line of credit for which any country using them pays the market rate of interest (on three-month t-bills). If a country does not use its allocated SDRs the interest rate it pays on its allocation is matched and offset by the interest it earns on its SDR holdings. SDRs are allocated in proportion to member countries’ quotas in the IMF. Quotas are based on each country’s economic size and importance in global trade and determined a country’s financial contribution to the IMF, its borrowing limits and its voting strength. This is an objective and sensible basis for allocations and does not and should not take into account the nature of each country’s government.

The WSJ also misrepresents the implications of the proposed allocation for the U.S. treasury, which like every other recipient of an allocation pays nothing unless it uses some of them. If the U.S. buys SDRs from another holder (only IMF member countries and ten International Financial Institutions such as the World Bank and the BIS), it earns interest to the extent that its holding would then exceed its allocation. If Greece uses its SDRs, it will not necessarily sell them to the U.S. Treasury. Greece could sell them or pay obligations with them to any other IMF member country willing to buy or accept them.

The IMF Articles of Agreement in which SDRs and the rules for using them are established are not the legislative product of the U.S. Congress (though the U.S. needed to support the adoption of these Article) and thus these rules cannot be changed by the U.S. Congress as suggested by the WSJ.

As noted in the WSJ editorial the size of the allocation seems to have been chosen to stay under the cap over which Congressional approval is required for U.S. support for the allocation. As allocations require 85 percent support of the IMF members by quota and the U.S. quota is 17.44%, an SDR allocation cannot be approved without U.S. support. The editorial is right (implicitly) that SDR allocations are not meant as aid and the current scheme proposed by the IMF seems to be a non-transparent work around the need for congressional approval to provide aid. My IMF colleagues Leslie Lipschitz and Susan Schadler explore this aspect more fully in “A New Global Plan to Help Struggling Countries Misses the Mark” http://barrons.com/articles/WP-BAR-0000029758  Sadly this undermines the legitimate purpose and role of SDRs in augmenting international reserves.

Review of John Tamny’s attack on Jack Kemp Foundation article

By Dr. Warren Coats

Dr. Coats is retired from the International Monetary Fund, where he was Assistant Director of the Monetary and Capital Markets Department.

In an article titled, “When the Ideas of Thinkers and Great Statesmen Are Perverted,” John Tamny offers what he calls “a semi-brief response” to a Wall Street Journal op-ed by Sean Rushton from the Jack Kemp Foundation, “Monetary reform would rebalance trade.”

Mr. Tamny wastes no time in launching his attack with the following: “Worse were the myriad factual inaccuracies, including a Bretton Woods monetary agreement that took place after World War II. Except that it took place in 1944.”  This is his only valid criticism in his not so brief discussion. As we all know, the Bretton Woods conference was in anticipation of the end of WWII and did not actually take place “after” the war.  Devastating, right?

Mr. Tamny launches his more substantive critic by noting that, “To be clear, all trade balances. Always.” Whether that balance is healthy or not, however, depends on its composition. Mr. Rushton’s article is about that composition. He discusses the implications of the fact that one of the ways in which we pay for what we import is by exporting U.S. dollars. The others are exporting U.S. debt (largely government) and the ownership of American firms and other private assets. Many countries wish to hold our dollars (it is the primary international reserve asset held by central banks) because so much of world trade is priced in and paid for with USDs.

Given all the many factors that determine what we import and export, the global demand for USD as a reserve asset makes our trade deficits larger than they would otherwise be in order to supply (export) those dollars. Tamny correctly notes that “the U.S. has run ‘trade deficits’ for longer than it’s been the United States.” Obviously such deficits were not the result of the world’s demand for U.S. currency. “The U.S. always ran trade deficits precisely because it’s long been an attractive destination for investment.”  In other words, other countries sold us more than they purchased in goods and services (our trade deficit) in order to earn the dollars to invest in the U.S.

But times have changed. Today, and since the U.S. left the gold standard in early 1970, most of the dollars earn abroad from our trade deficits (their surpluses) are invested in U.S. treasury securities. In short, dollars earn abroad via our trade deficits (in addition to accumulating dollars in foreign exchange reserves) are now largely invested in financing our government’s deficit spending. Even Mr. Tamny would not argue that this inflow of investment in the U.S. is contributing to our increased growth and productivity.

On the contrary, Tamny seems to be arguing exactly that. He says that: “we have a so-called “trade deficit” as a country precisely because the U.S. is a magnet for investors the world over. When we “export” shares in American companies that are routinely the most valuable in the world.” He seems to applaud selling our firms to foreigners when our government crowds out the domestic financing of our industries in order to finance our irresponsible government deficits.

Mr. Tamny is not content to label Mr. Rushton’s analysis false. He calls it “obnoxiously false” and “comically false.” Unfortunately these labels apply more accurately to Mr. Tamny.

Rushton claims and provides evidence that U.S. fiscal discipline weakened when Nixon closed the gold window. “No longer bound by fixed exchange rates and dollar convertibility, the U.S. government’s fiscal discipline broke down.” Obviously other political and demographic factors have also contributed to the alarming increases in U.S. deficits, but no longer needed to defend the dollars exchange rate removed an important constraint. To rebut Rushton’s claim and data, Tamny notes that our deficits were even higher during WWII. Truly. I am not making this up.

Turning to the dollar’s role as an international reserve asset, Mr. Tamny notes that Mr. Rushton “argues that thanks to ’high global demand,’ the ’dollar’s international position is always stronger and U.S. interest rates are lower than they would be otherwise.’” Added to all of the other factors influencing the composition of our external financial flows (our balance of payments), the world’s demand for dollars in their foreign exchange reserve holdings must increase their trade surplus (our trade deficits) or their investments in the U.S., either of which will appreciate the dollar’s exchange rate and lower interest rates in the U.S. relative to what they would other wise be. Mr. Tamny doesn’t get this. He says that Mr. Rushton “wants us to believe that a devaluation of the income streams paid out by the U.S. Treasury actually made them more attractive to investors.” I don’t really know what he means by that either.

Another of Mr. Tamny’s “obnoxiously and comically false,” or perhaps merely nonsensical statements is that: “if we ignore the obvious, that the sole purpose of production is to import as much as possible….” If he is relating production to imports, he presumably means producing for export. What we import must be paid for one way or another, i. e., by exports of goods and services, U.S. dollars for reserves, U.S. government debt, or ownership of U.S. firms.

I leave it to the reader to sort out what Mr. Tamny might mean by: “the path to a lower ’trade deficit’ is only possible if we’re willing to accept being much poorer.”

As a parting shot, Tamny mischaracterizes the views of the late Jack Kemp. Here’s what Kemp actually said, speaking in 1987:

“Why do we keep having these cycles? I believe it has to do with the burdens and privileges of the dollar’s unique international role. First, the extra demand for dollars puts a premium on their value that makes American exports less competitive. And on world markets, only a few cents means the difference between a sale and a loss. This increases our merchandise trade deficit.

“Second, the dollar’s role helps fuel Congress’s deficit spending. Foreign central banks buy U.S. Treasury securities to hold as reserves and to keep their currencies from rising—almost $100 billion in the last year and a half. This amounts to a special ‘line of credit’ that lets Congress spend resources that would otherwise be used to farm or manufacture for export. President Reagan used to say that to get Congress to spend less you have to reduce its allowance. Well, we may have reduced its allowance but we haven’t taken away its charge card. That’s one reason why every tax dollar is spent without cutting the deficit.

“Trying to compete in world markets under these conditions is like trying to run a race with a ball and chain around your ankle. We face a constant choice between giving in to pressure to let the dollar fall at the risk of inflation, or keeping interest rates high at the expense of a trade deficit and growing pressure for protectionism. This dilemma will continue until we stabilize the dollar, end the inflation/deflation cycle, and bring down interest rates with the right kind of monetary reform.”

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