Reforming the international monetary system in the
1970s and 2000s: would an SDR substitution account
have worked?
Presentation by Robert N McCauley*
Senior Adviser, Monetary and Economic Department
To the joint Asian Development Bank/Centre for International
Governance Innovation/Hong Kong Institute of Monetary Research
conference on “The BRICS & Asia, Currency internationalisation, and
international monetary reform”, Hong Kong, 10-11 December 2012
* Views expressed are those of the author and not necessarily the views of the BIS
Global crisis gives new evidence of dollar dominance…
 Dollar shortage as non-US banks scramble for dollars
 European banks need $ to fund US mortgage securities, loans to
Asian borrowers
 Dollar used in 90%+ of forward transactions
 Huge premium for dollars in forward markets
 Natural experiment in Polish & Hungarian forex markets: local
currencies trade vs € for months then back to $: $ stable equilibrium
 Unlimited Fed swaps to major central banks
…but also brings back a long-standing alternative: the SDR
 Ted Truman convinced US Treasury to support issuance of SDR
 Still SDR single-digit percentage of forex reserves
 Gov Zhou embraces Triffin, SDR-based international monetary system
 2008 BIS Annual Report argues that an SDR based system would still
required last-resort lending in constituent currencies
 Truman proposes that IMF issue SDRs to Fed/ECB/… to fund swaps(!)
A single point of failure: a need for pluralism?
 Kindleberger: leadership in global finance is stabilising
 Political scientists dub this hegemony
 Pluralism in international monetary system promises:
 Joint control of growth of international liquidity
 Fair sharing of rents
 Protection against errors/ self-interest of hegemon
Varieties of Triffin
 Original: US s-t debt growing with global econ undermines gold link.
 Like 1st speculative attack model of Henderson & Salant/Krugman.
 Ignored that Bank of England managed gold link with little gold.
 Genberg & Swoboda argue: It’s the policies, stupid!
 Generalised: Padoa-Schioppa: national policies unlikely to lead to
global liquidity (however defined) growing at global optimum
 Fiscal version: US government debt growing with global demand for
reserves is inconsistent with US fiscal sustainability.
 Ignores generation of safe assets w govt guarantees.
 Ignores ability of banks and other sovereigns to produce safe
assets in the dollar.
Hard to argue a global lack of liquidity (by any def)!
 True, 2011 CGFS report uses “shortage” twice as much as “excess”.
 But see Caruana speech to SEACEN governors in Ulaanbator.
 Central bank balance sheets swollen; over ½ of US Treas held by off’s.
 Safe assets shrinking with downgrades but expanding w deficits and
expansion of agency debt
 So those seeking more pluralism may look to substitution-type
remedies that lower dollar share without increasing global liquidity.
Downgrades take toll on government bond markets
International monetary reform
 Recurring doubts about ability of US dollar to continue to serve as the
primary global reserve currency
 Exorbitant privilege: unbalanced adjustment
 Relative size of US economy declining
 Dollar exchange rate weakening
 Size of US external liabilities rising
 Vulnerability to ‘tipping point’: disruptive transition to multipolar
or other dominant asset
 1960s, 1970s, 2000s: revival of old proposals: Kenen (2010), Bergsten
(2007), Camdessus (2009), Landau (2009), Palais Royale Initiative
(2011), Angloni et al (2011), Farhi et al (2011)
Reform plans
 1961-67: Special Drawing Right (SDR)
 Composite valuation, right to borrow convertible currencies
 Triumph of consensus over clarity
 Not a big reserve asset (2.6% global reserves)
- Strictly official sphere of exchange
- Unit of account, store of value, not a means of exchange
 How to make SDR more “useful” to allow it to take on the
properties needed to be a reserve asset
 New push: SDR “serves as the light in the tunnel for the reform
of the international monetary system”: Zhou (2009)
Substitution Account 1974
 1973-74: Part of C20 proposals
 Exchange USD for SDR through a Substitution Account (at IMF)
US worried about return paid on dollars in the Account
Others want US to pay off its liabilities
William Dale (US): “Unless the proponents of the various
schemes had some practical way of dealing with the problem
of financial obligation on the part of the reserve centers [i.e.
the United States], little progress could be made”
Overtaken by oil crisis
Substitution Account 1978
 IMF MD Witteveen proposes rich countries “deposit” dollars
equivalent to a fresh allocation of SDR into an Account at the IMF
(dollars to be invested in US Treasury coupon securities)
 Prevent SDR allocation from increasing international liquidity in
inflationary environment
 Begin to replace dollar reserves with SDR reserves
 Rejected by United States and Europe
 US would have to borrow dollars to deposit
 Could weaken confidence in dollar
 Some view as too lenient on US – want US to pay off liabilities
 Too small to make a difference
Lessons and unresolved issues of early versions
 US support crucial to any scheme’s success, but US Treasury is
ambivalent over setting up a reserve rival to the US dollar.
 The appropriate return on SDR/USD liabilities/assets in the Account?
 The need for the US to take on a substantial share of any burden of
keeping a scheme’s assets as large as its liabilities.
 The desire of the Europeans that the United States amortise its
obligations, making the international monetary system symmetric.
 Governance of IMF: since less developed countries seek an important
voice in negotiations, need to look beyond G10 if IMF to be involved
Substitution Account MD de Larosiere proposal 1978-80
 Cautious response, no drive from Ministers March 1979
 US Treas Solomon: enhance use of SDR w/o hurting $ confidence
 G5 deliberations (UK, DE, FR, US, JP) April-August 1979
 Legal obstacles, burden of adjustment and exchange risk
 June 1979 Financial Secretary Nigel Lawson: “we should not
waste valuable manpower on matters such as the IMF
substitution account. Over the years I can recall no aspect of the
financial scene where so much high-powered effort has been
expended to so little return”
 August 1979: IMF Exec Bd prolonged wrangling gives no positive
advice to Ministers
 October 1979: Ministers meeting Belgrade: $ crisis, no progress
 April 1980: Abandoned
Obstacles by 1980
 Political – needs to pass national legislatures
 No mechanism to ensure US pays off its liabilities (shift from
central banks to IMF)
 Rich countries would benefit most (constrains use of IMF
 Ensuring solvency
 How set returns on SDR liabilities and $ assets
 Burden sharing (US vs others)
 Terms of liquidation
 IMF simulations suggest possibility of substantial losses (up
to 35% of capital)
 Open economy Fisher hypothesis that higher yields offset
depreciation did not hold: USD depreciation exceeds modest yield
premium over SDR rates
 Interest payable options:
 Treasury bill rate
 20 year Treasury bond rate
 Whitelaw: “Ultimately, the substitution account could be effectively
guaranteed only if the US Government followed economic policies
that tended to maintain the value of the dollar”: but fear that
mechanism reduces discipline on US
 US can’t undertake to guarantee the SDR value of the Account – so
how is the risk shared?
 US vs creditors (at least 50-50)
 IMF – via gold reserves
Graph 1
SDR and US Treasury bill yields, 1980-2010
In per cent
Source: IMF.
SDR rate payable on SDR claims on Account
US Treasury bill rate earned by dollar liabilities of Account
Graph 2
US Treasury bill and bond yields
In per cent
Note: Due to data break from January 1987 through September 1993, the 10-year bond yield is used instead.
Source: Federal Reserve Economic Data.
Majority view: US should pay higher of 20-year bond rate or
Treasury bill rate
Burden sharing
 Participants contribute callable capital
 IMF pledges gold to support the value of the Account
 20-25 million ounces (out of total 32 million) to cover fund
of SDR50 billion
 20% of value of Account
 Equivalent to amount of gold sold to benefit less developed
 Gold proposals contested
 Would benefit rich countries, contravene IMF Articles
 At what point is the decision on liquidation taken?
 How long will unrealised losses be allowed to run?
 SDR50 million in deposits of dollars
 Profits of 25 million ounces of gold
 Optimistic timing:
 mid-1980 start, Treasury bill rate paid on dollars
 Historically more realistic
 Mid-1981 start (need to gather the participants and enact
legislation where required)
 20-year Treasury bond rate (would work)
Graph 4
Substitution Account’s solvency: baseline scenario
In billions of SDRs
As a percentage of assets
Sources: IMF; authors’ estimates.
Graph 7
Account’s solvency: start mid-1981; pay Treasury bill rate
In billions of SDRs
Sources: IMF; authors’ estimates.
Insolvent within 5 years and would not have
recovered, even given rise in price of gold since 2008
Graph 8
Substitution Account’s solvency: start 1980; pay Treasury bond yield
In billions of SDRs
As a percentage of assets
Sources: IMF; authors’ estimates.
 Existing studies don’t take account of the complex reasons for
failure in 1980
 These obstacles still persist (burden sharing, risk sharing,
amortisation, politics of main beneficiaries)
 Start date is critical to outcome (but hard to judge ex ante): our
scenarios start with USD trough (more favourable)
 Optimistic scenario that IMF gold was deployed is still not
enough to ensure solvency unless US was convinced to pay 20year bond yield (currently 2-5 yr bonds usually held as reserves)
 Need to keep re-opening the Account to make an impact on
distribution of reserves (SDR50bn cumulates to 5% reserves by
2010) but timing etc. complicated

Reforming the International Monetary System in the 1970s and 2000s