News: IMF head, Dominique Strauss-Kahn, expects currency basket for reserves

The Globe and Mail is reporting that countries might move their foreign currency reserves to a basket of currencies such as Special Drawing Rights.

There have been many commentaries on SDR’s, especially since China’s recent suggestion of their usage, for example Wikipedia, the University of British Columbia, Wall Street Pit, The Seven Scholars, etc. A simple google search is revealing.

The risk of a basket of currencies held in reserves for drawing rights is that exorbitant privilege would be available to all countries whose currency is part of the basket that makes up SDRs, probably proportional to each state by the percentage of their use to back SDRs. This privilege would permit many countries to engage in fiat seigniorage. While over a long enough period of time need not necessarily be harmful (as seigniorage will eventually devalue the currency – and probably its percentage of use to back SDRs), seigniorage is counter-incentivized in short term political work, and I believe it encourages reckless spending and irresponsible behaviour. In other words, there’s a risk that every country that forms part of the basket of currencies could engage in the same seigniorage that the U.S. has engaged in that has in no small part (in my opinion) contributed to the current so-called “great recession”.

The global economy’s exposure to abusive exorbitant privilege could be tempered by changing the percentage make-up of currencies based on objective market valuations (i.e. making the currency basket reflect some measure of the “underlying fundamentals” of the currency’s issuing country), and by making such changes without delay.

Extending exorbitant privilege to other countries is one of several risks inherent to the widespread use of SDRs in place of the U.S. dollar, and there are many inherent risks (and costs) to a single-state issuer of the global reserve currency.