IMF Gold & the SDR

Russia and China have called for a new world currency, perhaps involving gold…

RUSSIA HAS proposed that the International Monetary Fund (IMF) create a synthetic currency, based on the already used Special Drawing Rights but changed to include some element of gold backing, writes Julian Phillips of the Gold Forecaster.

The Kremlin has urged adoption of this currency to replace the US Dollar as the world’s prime reserve currency. Indeed, both China and Russia have proposed new currencies, not so much in the hope that their proposals will be accepted, but bringing to the attention of the world the fact that the Dollar is losing credibility and not serving the role is should as the world’s reserve currency.

At the same time the IMF, thanks to the G20 summit in London, was given a much stronger global role than ever before by the addition of nearly $1 trillion to its balance sheet. And with that $1 trillion created as Special Drawing Rights, it seemed appropriate to Russia to elevate the SDR to a real global currency, rather than the synthetic bookkeeping role it has at present.

With the IMF now placed in such an important role in the global monetary world, and if such a proposal were adopted, would it work?

The IMF established the Special Drawing Rights to serve as the reference point of the global monetary system. However, it never made it there, and now serves solely as an accounting measure of value with little practical use. This was because the United States controls the IMF through its voting power (owning 17.3% of the votes, with 85% approval needed for a resolution to pass). So the Special Drawing Right - which is valued as a basket of Dollars, Euros, Yen and Sterling - was seen as an extension of the Dollar, and only in a world run by the US.

No nation will be happy with the States continuing to pull the strings on such a global currency. The need is now for a currency that is truly global currency above any local national interests.

Why didn’t the money crisis of the 1970s - the last great inflation - lead to a better world monetary system? Because there was insufficient political will to do so. Now the IMF has been allowed to issue $250 billion in SDR’s to stimulate the world economy, but if the measures proposed by the G20 conference do not succeed in rectifying the global monetary system, the currency world will begin to break down.

As it is, once the Dollar retreat back to the States (a.k.a. de-leveraging) is complete, it looks like the Euro will rise strongly again against the Dollar. For the currency world to remain stable the exchange rate between these two currencies must remain relatively stable. This stability remains under threat. With potential financial mayhem just being skirted, never has the time been as pressing as now for a global solution to the world’s credit and associated crises. Without global unity on this, there will be no solution and then it will be every trading bloc for itself!

Provided China and Russia are given a greater say in the IMF, and the US stranglehold over it is removed by lowering its voting power below 15%, then that body will have mandate to “manage” the global monetary system in a new way. With the threat of currency collapse hanging over us, it also looks like only the IMF has the support of the world to adjust and agree any fundamental reforms to the monetary system.

This is a view confirmed at the G20 meeting by both China and Russia calling for new global reserve currencies. While there is little chance that these proposals will be accepted, China and Russia made their presence known and initiated reform. Certainly the time has come when China cannot be ignored on such matters. And while the US Treasury Secretary has said the US Dollar will remain the global reserve currency, he was open to look at suggestions.

Now Russia has said it would favor the inclusion of Gold Bullion in the basket-weighting of a new world currency based on Special Drawing Rights issued by the International Monetary Fund. With the uncertainty affecting foreign exchanges and exchange rates, such a move could add increased credibility to the currency system.

Bear in mind its price would be a reference point and the move would not involve Buying Gold on the open market. However, with bankers still resistant to gold, its inclusion in the SDR may be premature. If not, we would then expect to see central bankers remove their dislike of gold completely and let it find its own level.

Russia has been Buying Gold for the last two years, slowly but surely. It intends to raise the gold content of its foreign currency reserves to fully 10%. By doing so it adds action to intention for gold to become part of the monetary system. The silent but difficult to ignore presence of gold in so many central bank vaults tells us that the return of gold in support of currencies may well be possible now.

With the US still controlling the IMF even Washington may find such an additional reserve currency acceptable. This would certainly diminish, over time, the impact of the US Dollar’s swings on global foreign exchanges, and thus on global trade. With the Obama administration trying to fortify the IMF at the meeting of the Group of 20, now is a good time to launch the proposal and for adjustments to the Fund and its SDR to be made.

The IMF’s view of gold continues to be one of respect of a vital reserve asset, so there should be no barrier provided it supports currencies and does not compete against it. The G20 will only follow such a move if gold is needed to shore up confidence in currencies, which is becoming abundantly clear to all now. Certainly, we are not quite at that point at the moment.

But how far away from that are we? Should major currency crises begin, Gold Bullion will quickly become a very visible anchor to investors be bought as such. This may force central banks to re-recognize it as a stable foundation in extreme times.

So if the US is prepared to take a lesser role in the IMF, it should gain the support of the world and such structural changes to the global monetary system would follow. Sadly, as national interests, not global ones, govern international policies, we doubt whether the States would lessen its dominant role, just yet. A little more pain may be needed first?

For now, the present IMF view of gold remains that:

“Gold is an undervalued asset held by the IMF, and provides a fundamental strength to its balance sheet. Gold holdings provide the IMF with operational maneuverability both as regards the use of its resources and through adding credibility to its precautionary balances.

In these respects, the benefits of the IMF’s gold holdings are passed on to the membership at large, to both creditors and debtors. The IMF should continue to hold a relatively large amount of gold among its assets, not only for prudential reasons, but also to meet unforeseen contingencies.”