As the Group of 20 struggles to find a way to ease the extreme volatility that has plagued foreign-exchange markets in recent years, some see an answer in an obscure asset used only by the International Monetary Fund that has been rejected by investors for five decades.
The unit is the Special Drawing Right, or SDR. Created in the late 1960s, it was meant to be an international reserve asset, a unit of exchange backed by the world's major economies that could anchor the global monetary system the way gold had done previously.
That never happened, mostly because private companies and investors never bought in. SDRs currently represent about 4 per cent of international reserves, compared with more than 60 per cent for the U.S. dollar and about 26 per cent for the euro.
But some think the SDR's time might have arrived. France's Nicolas Sarkozy, who holds the presidency of the Group of 20 major economies, plans to spend the year leading a debate about overhauling the international monetary system, including an enhanced role for the SDR. People's Bank of China Governor Zhou Xiaochuan has been an advocate for two years. World Bank President Robert Zoellick said Friday the governments that issue the currencies that make up the SDR should form a group that meets regularly with the IMF to review monetary and currency issues.
The SDR is getting a fresh look because of concern the world economy's reliance on the dollar is the root of elevated volatility in asset markets.
Cross-border capital flows equate to about 15 per cent of global gross domestic product, compared with 3 per cent at the turn of the last century, meaning "shocks, both real and financial, are now transmitted quickly across financial markets," according to a paper by Bank of Canada Governor Mark Carney that was released Friday at a conference in Paris where G20 finance officials are now meeting.
Because so much of what goes on in the world economy is transacted in dollars, changes in the value of the U.S. currency sends ripples through the entire global financial system. Mr. Sarkozy and others argue that volatility could be diminished by introducing alternatives to the greenback. Enter the SDR, an international unit of exchange that already exists, if only on paper. If global trade shifted to SDRs, then the Federal Reserve's U.S.-centred monetary policy would matter less to the rest of the world.
In theory, "the SDR is a competitive alternative to the dollar," said Domenico Lombardi, a senior fellow at the Brookings Institution in Washington and a former IMF official.
The challenge for the fans of the SDR will be turning theory into reality, something that even the concept's biggest promoters say would take years to achieve.
SDRs can't be found at the Bank of Canada's currency museum, and no bartender ever has been passed one to add to the collage of international notes on the wall behind the bar.
The SDR is an administrative unit at the IMF whose value is tied to a basket of currencies that includes the dollar, the euro, the yen and the pound. SDRs are backed by financial commitments from the fund's 187 members and are what the IMF uses to rescue countries in crisis. Under the treaties that govern the fund, the rescued country can convert those SDR loans for any freely-traded currency, converted at rates that change based on market values.
SDRs could help bring about a "safer world," but only if there were a central authority managing the supply on a continuous basis, said Paul Masson, an economics professor at the University of Toronto's Rotman School of Management who is currently studying the idea.
The barriers to achieving this are considerable. The IMF is limited in how it uses SDRs because allocations require legislative approval by some member countries. To make the SDR the true global reserve currency, all the dollars, euros, yen and pounds would have to be removed from central banks around the world and converted and swapped for the new unit. The IMF also likely would have to become something even closer to a global central bank, another idea that works on paper, but falls apart when sovereign governments are asked to yield power to an international body.
A more plausible scenario, said Prof. Masson, would see SDRs take on a "minor supporting role" in the global economy. Rather than supplant the dollar, SDRs could become an alternative for central banks and others looking to diversify their holdings. "This might provide a bridge to scenario one," where the SDR is the central means of global exchange, "should the time ever be ripe to introduce it," said Prof. Masson, a former official at the Bank of Canada and the IMF. "But this is surely a long way off, and would probably only come about after a major crisis with the current system."
But there appears to be a more timely goal for putting some emphasis on the SDR: coaxing China to play a more active role in the global economy. Regardless of whether the SDR ever takes off, Mr. Sarkozy and others are vocal about how they think the Chinese yuan should be added to the SDR basket. But under current rules, the basket must consist only of currencies that are "freely" traded. That excludes the yuan because China keeps tight controls on the amount of yuan circulating outside the country.
"The main issue is to make the yuan more convertible," said Uri Dadush, director of the international economics program at the Carnegie Endowment for International Peace in Washington and a former World Bank official. "It is of important symbolic value." The Obama administration supports adding the yuan to the SDR basket. Whether the U.S. supports a greater role for the SDR in the global economy remains unclear. American governments have long opposed the idea because of the benefits the U.S. accrues from controlling the world's de facto reserve currency, Mr. Lombardi said.
Almost all agree that the success of the SDR as an international currency - or the continued role of the dollar, for that matter - will be determined by the private individuals and companies that execute currency transactions worth $4-trillion a day. "They can announce whatever they like at the G20," Mr. Dadush said. "Mr. Sarkozy, [German Chancellor Angela]Merkel and [Chinese President]Hu Jintao aren't going to decide whether the dollar will be the reserve currency."