Roles And Functions Of Special Drawing Rights

There are many roles and uses of Special Drawing Rights which created by IMF. In 1969, it is used to maintain the constant exchange rate system that was set by the Bretton Woods. IMF’s member countries who want to participate in this system needed official reserves from government or central bank holdings of gold. Not only that, they should buy the domestic currency by using the foreign currencies in foreign exchange markets. This can maintain and sustain their exchange rates. However, the Bretton Woods system collapsed after a few years later. This had caused there was a floating exchange rate in the major currencies.

Besides, SDR can be used to balance the accounts of the participants. This can achieve the requirement for supplementing to current reserve. If the IMF’s members want to achieve the requirement, the SDR can be used to obtain foreign exchange. This transaction can be done by designation by IMF of one member to another member to exchange the SDR to freely usable currency. The designation is based on the conditions of their payment’s balance and reserve positions. There is a limitation for the member to provide currency although there is an agreement to set a higher limit by the IMF and members. The holding of SDR should not more than three times.

Furthermore, SDR is also used to settle financial obligations. The member countries can get the loans from SDR at the agreed maturities date and interest rates. After that, the countries should repay the loans and payment of interest with SDR.

Other than the uses above, there are two ways that the SDR can perform as the protection for the financial requirements. To discuss about it, first, the participants may allocate the SDR for the time period that had promised before by recorded it in a register. Besides, the second way is the participants may have the same opinion that SDR would perform as the protection for the financial requirements and the transferor would receive back the SDR when the requirement had been achieved.

Basket of Other Currencies to find Out the SDR’s Value

Before that, the SDR’s value was equivalent to 0.888671 grams of fine gold (International Monetary Fund Factsheet, 2010). It was same with $1 USD. As mentioned above, the Bretton Woods system collapsed. Due to this, the SDR’s value was determined by basket of other international currencies which consist of Yen, Dollars, Pounds and Euros. At the website of IMF, there will show the value of US dollar of the SDR every day. The total value of the amounts of the four currencies which is in U.S. dollars as mentioned above is the SDR’s value. Besides, the currencies’ values are based on exchange rates quoted at each day in the market of London. Afternoon rates of the market in New York are used if the market of London had been closed.

The Executive Board reviews back the basket currencies every five years. This is because he wants to emphasize significance of currencies throughout the whole world’s financial systems. The value of the exports determines the weights of the currencies in the SDR basket. It is also determined by the amount of reserves which were held by other members of the IMF. The tables below are representing the value of SDR in this recent ten years time: [1] 

January 2001 – December 2005

ISO

Currency

Weight

Value

USD

US Dollar

44%

$ 0.5770

EUR

European Euros

31%

€ 0.4260

JPY

Japanese Yen

14%

¥ 21.0

GBP

British Pound

11%

£ 0.0984

January 2006 – December 2010

ISO

Currency

Weight

Value

USD

US Dollar

44%

$ 0.6320

EUR

European Euros

34%

€ 0.4100

JPY

Japanese Yen

11%

¥ 18.4

GBP

British Pound

11%

£ 0.0903

The Interest Rate of SDR

To determine the interest charged on IMF loans, we need to base on the interest rate of the SDR. Besides, it also calculates the payment of interest based on the percentage of the subscriptions of the quota and charges the members based on their holding and allocations of SDR. The interest rate of SDR is calculated every week.

SDR’s Allocations

The allocations of the SDR by the IMF to its members are based on the percentage of their quota. It receives on the excess if the member’s holding of the SDR is above the allocation. However, if it holds fewer SDR than allocated, it needs to pay interest on the loss.

General allocations and special allocation (Factsheet – Special Drawing Rights, n.d.) are the two kinds of allocations. General allocations mean that it needs to set the long term requirement as the basis to complement on hand reserve. There are three times to make the decisions to allocate SDRs. The allocation will enhance the holdings of the SDR by the members and the growing of the SDR allocations.

Special allocations mean that all members are enabled to join the SDR system equitably and do some correction for the truth that others countries which had joined the after 1981. It was executed on September 9, 2009 (Special Drawing Rights, 2010). It also makes the cumulative allocations of SDR of the members to increase by using a common benchmark ratio.

Membership of IMF

There are 187 countries currently is the members of IMF. A country must apply and then be admitted by a majority of the existing members only will successful become part of them. Every member of the IMF is distributing a quota when they joining the group that which refers to the size in the international economy. The membership of the IMF agreed to rebalance the quota system in May 2008 in order to reflect the realities of the global economic changing.

What is a Quota [2] ?

Most of the IMF financial resources are generated by the quota subscriptions. Every member is giving a quota according to their relative size in the economy of world. (Boosting representation of emerging markets and low-income countries, 2010) The voting power and the maximum financial commitment has determine by the member’s quota. In addition, the protection of poorest members’ voting share is promised by the quota.

The Functions of Quota

Any reassessment of the quota formulas should take into account the functions of quotas. Multiple functions can be found in the Fund’s Articles of Agreement. Quotas (i) fix the maximum amount of financing a member is obligated to provide to provide to the Fund, (ii) determine voting power in the Executive Board, (iii) bear on a member’s access to Fund resources, and (iv) determine a member’s share of general SDR allocations.

Traditionally, a critical role of quotas has been the provision of financial resources to the Fund since a monetary and financial institution could not function without an adequate supply of resources. This remains the case, although the financial role of quotas has been affected somewhat as alternative sources of finance have been developed, particularly the increased availability of borrowed resources to supplement quotas and the growing role of administered resources to provide concessional assistance to the Fund’s poorest members. Besides that, Quotas determine the distribution of voting power in the Fund. The Fund’s responsibilities outside of those directly related to lending have grown over the years, most recently with the various initiatives has a relationship with the reformation of the global financial architecture (e.g., the fostering of international standards). Measures have been taken in the past to seek to ensure adequate representation for all members (e.g., increases in small quotas). However, for many smaller and medium-size emerging market and developing country members, quota-based votes may not adequately reflect the role these countries play in the world economy. Then, Quotas continue to play a crucial role in determining the demand for Fund resources. Quotas serve as the basis for access to such resources in the great majority of Fund-supported programs. Over the years, however, the relationship between quotas and access has become more elastic, especially as of late when the demand for Fund resources has become more unpredictable because of the increased role of capital flows in causing balance of payments disequilibria. Waivers of the Articles’ limits on access to Fund resources have been granted where necessary to allow access in line with operational limits. Lastly, the allocation of Special Drawing Rights (SDRs) has the function of acting as an international reserve asset.

Description of Fiat Money

History of Fiat money:

A fiat money is a medium of exchange and known as the paper money. As we all know that fiat money is money that is declared to have value even if it does not. Fiat money is valued by the people that use it so there is no any production cost to the fiat money and the supply of fiat money can never be limited. Normally, the value of fiat money is always depending on the economy of each country (History of Fiat Money).

As mentioned that, fiat money no production cost and supply of a fiat money can be unlimited so that hyperinflation will be occurred if there are too much of the fiat money flow in the market and cause the purchasing power of the money is lower compare with past. As a result, issuers such as central bank should control and supervise the volume of the fiat money. The United States has prevented hyper-inflation by shifting between a fiat money and gold standard over the past 200 years.

In Malaysia, the paper money we called it as ringgit Malaysia which consists of different value on each fiat money as others countries. The currency for our paper money is stable compare with foreign countries because our Central Bank manages the monetary stability well and lower down the fluctuation of currency value.

Evolution of Fiat money:

910AD- China is the first country experiments with the paper money- The fiat money is nearly used around hundred years but the paper money is rejected due to the hyper-inflation as the supply of the money more than the production.

1500’S- Spain becoming the richest nation in the world after collected gold from Mexico and the new world. After that, Spain spent most of their resources to extinguish pirates and then their excessive consumption cause the shortage of gold hoard. Then, they changed to financing the war with debt, finally bankrupted.

1716- John Law persuaded France to use the paper money in the market and declared all taxes necessary paid with it gain acceptance. The paper money becomes more popular than coin and cause to no limitation in printing, excessive moneymaking and planning and fraud. Overvalues in printing the excessive paper money eventually destroyed the system as well.

1791-The French Government again tries to use the paper money as country currency. However, the French Government issued out the “assignata” which is the interest rate for every personal own properties after they confiscated the land owned by aristocrats Some land was auctioned off in order to exchange for these new interest rate, inflation increased rapidly to 13,000% by 1795. After that, the “assignate” had been replaced by gold franc due to the Napoleon ended up the revolution, which set up over a century of development for France in that period of time. In the 1930’s, Bank of France transform fully into the Government after the Socialists had brought the bank. They eliminated the gold backing of the currency as fast as possible and made the franc as the determinate of fiat money in France. The currency value had dropped 99% during the past 12 years.

1853- In Argentina, the development of gold standard is around 100 years. After that, the central bank of Argentina was formed in 1932; the downfall of the Argentina economy was started afterward. Then, Juan Peron involved in 1943 revolution and exhausted of reserves causing economy collapse in the year. Argentina continued on this line of paper money usage. As a result, the ranking of Argentina economy is falling from the eighth largest to deepest in the world, which it has no financial power to recover until today due to the serious impact to their country economic.

1862-The 16th President of United States Abraham Lincoln succeed to pass the Legal Tender Act and then allowing the United States Government to issue out their own paper money. The decision was supported by the government without any of promises so that a tremendous inflation occurred that caused the practice fall down rapidly out of grace until year 1913 in which the Federal Reserve System was developed.

1923 – Weimar Republic was established in 1919 in Germany in order to lower down from its total loss result from the world war because Germany needs to take the responsibility to payback the war reparations which are huge amount. The huge amount of debt caused the country was devoid so found no other alternative but to simply print the money in large amounts to make the payments on the reparations. The consequence was absorbed most of the income from whole middle class in the society, total value of savings had been destroyed, and paying to fulfill the reparations in front of the angry society in whole Germany.

The US dollar eliminates the gold standard in stages below:

1934-First of all, President Roosevelt was 26th President of the United States revalued gold to print out more paper money in the United States market, with the expectation to increase the GDP of the United Stated current economy so that can eliminate the depression in the society.

1944- One of the steps that US try to substitute the gold by dollar is offered out the Bretton Woods Agreement. The price of gold is around $35 per ounce of dollar so that every foreign nation is available to obtain their own paper currency if they could afford either gold or US dollar because the US dollar and gold are the determinate of the world financial instrument. For the other point of view is meant that each nation’s volume of currency was depended on the amount of gold and US dollar.

1971- President Nixon ended up the gold trading and no more ending convertibility of dollars to gold. This scenario happened because of the US World Bank was printing excessive dollars and living standard beyond its means. As a result, most of the foreign nations which led by France discovered this benefit and began to require to get the payment of gold, collapsing the system because US faced major outflow of gold. (J.Greene, 2004)

Relationship between IMF and World Bank

As we all know that, the International Monetary Fund (IMF) is an intergovernmental organization function in the management role of international financial system. The main purpose is achieved by controlling exchange rates and balance of payments global market in the world.

Besides that, IMF also supports financial aids and technical assistance to member nations when they are facing financial crisis. For example, IMF will combine with the World Bank provide the financial support funds to the poor countries such as some of the poor Africa countries which is facing the bad economy crisis and the collapse of economy. However, the funds that loan out by IMF and World Bank are considered as the debt trap because of the high compound interest rate charge by IMF to the poor countries and cause them unable to payback their loan. In fact, the cooperation between IMF and World Bank to loan out the funds to poor countries is aimed to absorb their natural resources in that indebted countries if they are unable to cover the repayment of debt.

In addition, the Fund that provided by the IMF and World Bank has the purpose of assisting the developing foreign countries to help them to achieve the stability in the economic conditions and reduce the levels of the poverty. The stability in the economic circumstances can led to the high GDP and rise up the living standard in each country so that the poverty will be lesser in the market level. The purpose of the IMF is established to speed up the development and growth of the international economy, provide the stability in the financial sector and avoid the fluctuation in the monetary market. To attain the goals, the IMF plan to:

Promoting worldwide cooperation in the financial sectors.

Facilitating the balanced development in the global trading and stimulating the employment rate and hence reducing the levels of poverty.

Contributing to the exchange rates stability.

Eliminating the restriction that block the global trade.

Providing impermanent financial sources to the member nations and helping them to stabilize their payments’ balance.