The Money View

Bank or no bank?

A money view of SDRs

In a market economy, when you need something, you go out and buy it. Liquidity is no different, in that respect at least. If it is market liquidity that you need, you go to a dealer, who stands ready to buy what you are selling. You pay for the convenience, though—the dealer is getting more for the same asset than you are. If it is funding liquidity that you need, you go to your bank, who stands ready to lend. You pay for the convenience, though—the bank is paying less for its funds than you are.

Stick with funding liquidity for a moment. A bank is well suited to provide such liquidity, since a bank's liabilities are money, and it can create them at will. If the need for funding liquidity is systemic, the bank that can provide it must be the one whose liabilities are interbank money—the central bank.

And if the need for liquidity is international? The country that issues the world's reserve money can create more of it, and that might be enough to stave off the crisis. Might some other asset do the job?

The eurozone crisis has sparked fears of a global need for liquidity. Domenico Lombardi and Sarah Puritz Milsom propose that a new allocation of special drawing rights could increase eurozone countries' ability to backstop the peripheral sovereign debt that still constrains their banks' ability to raise funds.

Do SDRs provide international liquidity? Can the IMF serve as a bank, creating more money to meet the world's need for liquidity?

The SDR is a reserve asset, in fact a reserve asset only for the top of hierarchy of money, as they can be held only by central banks. The SDR is opaquely defined as "a potential claim on the freely usable currencies of the IMF member countries". This linguistic muddle reflects the bureaucratic muddle that surrounded the SDR's creation. "Paper gold" or credit money, went the debate, and in the end the SDR is neither.

Gold—outside money—is distinguished by its aggregate stock's independence of short-term liquidity needs. Credit—inside money—is highly responsive to short-term liquidity needs arising from ordinary banking business. The SDR, for its part, is created with the consent of 85% of the votes of IMF members, so it has neither the indifference of gold nor the responsiveness of credit. 

In that they are a purely financial concoction, SDRs are arguably more like credit than they are like gold. But credit money is a claim on the issuer, and SDRs are carefully described as potential claims, and not claims on the IMF, but rather claims on the "freely usable currencies of the IMF member countries".

In practice, this means that the IMF acts as a broker in the market for SDRs, matching buyers and sellers. But it does not—can not—act as a dealer by buying and selling on its own account. What happens, then, when a seller cannot be matched with a buyer? The IMF can, in theory, assign the transaction to a member central bank, who would be obligated to provide national currency for the SDRs. This is in sharp distinction to a bank, which must allow its own balance sheet to fluctuate in size in the handling of payments.

SDRs could back the extension of guarantees of eurozone sovereign debt to European banks. But the eurozone's funding needs are surely in the hundreds of billions of euros, if not into the trillions. If those guarantees were called upon, it would be euros, not SDRs, that would have to be paid to make whole the private holders of sovereign debt. The SDRs would have to be sold. The IMF would be powerless to assign them in sufficient size to generate the needed euros.

The IMF, this is to say, is no bank. Because it cannot, in practice, make liquid the market for SDRs, a new allocation would turn a funding liquidity crisis on the part of European banks into a market liquidity crisis on the part of central banks. Rather than eurozone banks being unable to borrow, the Eurosystem would have no way to sell a trillion euros' worth of SDRs. Such a crisis unlikely to come about, I hasten to add. Market participants and central bankers will look through the proposal and see that it creates no new liquidity.



Great post.

I have a question.

Is the author saying that the SDR IS CURRENTLY NOT usable for liquidity creation by the IMF?

Or, is the author saying that EVEN IF the IMF (via its shareholders) DECIDES to make the SDR a money liability (electronically, only for central banks), with national bonds as the asset (perhaps in some securitized form representing all the fiscal authorities), and had explicit authority to issue SDRs to central banks and take the new bond as an asset, that that wouldn't theory, of course?

My senses is that most un-thinking (i.e., textbook-worshipping) economists would say this is possible. In fact, it seems to me it will be tried.

The reason it wouldn't work would be politics and the difficulty of creating demand for it via taxing authority, but not existing theory. Economists could then say, oh well, this silly thing called democracy got in our way, but we would have been right if we were kings.

Any help appreciated.


My argument is that a general allocation of SDRs in their current form, as proposed in the paper I linked to above, would not create the needed funding liquidity to support the holding of European sovereign debt by eurozone banks.

SDRs can only support a guarantee in euros if they can be sold for euros. At the required scale, the market for SDRs is not liquid, so that guarantee would not be credible.

To respond to your comment, the IMF could not unilaterally decide to make its liabilities serve as money. "The market makes its money", as Hicks said in A market theory of money. The dollar is international money for a number of reasons, including the centrality of the US in world trade and finance. These cannot be changed by decree.


Here is how I understand the issue, conceptually.  

Suppose there are two countries in the world, US and Europe, and the IMF expands SDRs by 100, allocating 50 to each country.  That means that each provides the equivalent amount of their own national currency, which then sits on the balance sheet of the IMF.  In effect there is a swap of IOUs between the IMF and ECB, and both balance sheets expand, and another swap between the IMF and the Fed, again both balance sheets expand.  

But the world reserve currency is the dollar, not the SDR, so what the ECB needs (to lend to its banks, or member National Central Banks) is dollars.  It can now approach the IMF to borrow the new dollars sitting on the IMF's balance sheet, 50 SDRs-worth.   For ECB, long and short positions in SDR net out, and the net effect is the same as if it had done a liquidity swap with the Fed, except that the IMF sits in between as counterparty.

I think we can agree that this transaction amounts to an increase in world liquidity.  The source of the increased liquidity is however the expansion of the Fed's balance sheet--the IMF is just a conduit.

Alternatively, and equivalently, the ECB could sell its SDRs, and the IMF would assign the sale to the US, and pay out to ECB in dollars.  Again the effect is essentially a liquidity swap.  This is the case you treat in your post, since you are thinking of ECB as a broker.


"But it does not—can not—act as a dealer by buying and selling on its own account. "

The last time I checked, the IMF was the largest owner of SDRs, all held on its own account.


"That means that each provides the equivalent amount of their own national currency, which then sits on the balance sheet of the IMF."

As far as I know, the IMF doesn't run the SDR program on its own balance sheet, it just administers the SDR program. Using your example, the EU and the US issue promises to currency which are held in some mutual account managed by the IMF, and that account in turn issues SDRs back to the EU and US. So in effect, the IMF doesn't swap its own promises with the EU and the US. Rather, the US and EU are swapping promises with each other with the IMF as facilitator.


To paraphrase Kindleberger, SDRs are the Esperanto of the monetary world.


I couldn't resist commenting. Well written!

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