How far SDR’s have been able to solve the problem of international liquidity?


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As the Bretton Woods system started facing problems, and the pressure on the dollar increased, a new reserve asset named SDRs was created by IMF in 1967. This   international currency was allocated to the imf member countries in proportion of their quotas. The biggest benefit of SDRs was that there was a provision for international money to be created without any country needing to run a BoP deficit or to mine gold. Its value lay not in any backing by a currency or a real asset (like gold), but in the readiness of the IMF countries to accept it as a new form of international money.

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Any member country, when facing payment imbalances arising out of BoP deficits, could draw on these SDRs as long as it maintained an average balance of 30% of its total allocations. It could sell these SDRs to a surplus country in exchange for that country’s currency and use it for settlement of international payments. Every member country was obliged to accept up to 3 times its total allocations as a settlement of international payments. It was an interest bearing source of finance, i.e. countries holding their SDRs receive interest and the one drawing them pay interest. These rates were determined on the basis of the average money market interest rates prevailing in France, Germany, Japan, UK and US. Only the member countries of IMF and specific official institutions are eligible to hold SDRs. It is also an account of all IMF transactions.

 

The value of a SDR was initially determined as equal to that of a dollar, i.e., one ounce of gold was equalized to 35 SDRs. Later, its value was revised and put equal to the weighted average value of 16 major currencies – US dollar, yen, pound sterling, DM, and French Franc. Both the times the weights were based on the importance of the respective countries in world trade. An important advantage of SDRs was that its value was more stable than that of individual currencies. This happened because it derived its value from a number of currencies, whose values were unlikely to vary in the same direction and to the same extent thus making it a better unit than a single currency.

 

However, despite the introduction of SDRs, the problem of international liquidity crisis was not solved. US gold holdings had reduced considerably and by 1979, its reserve turned negative as the BoP deficit increased drastically. There was great pressure on the US in the early 1971, because a number of countries had to buy a lot of dollars to defend their exchange rates. The condition of US worsened because it suffered from a trade deficit causing great unemployment.

 

This problem continued for some period of time thus reducing the validity of SDRs to resolve the international liquidity crisis.

 

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