The head of China’s central bank is calling for countries to replace the U.S. dollar as an international reserve currency with something called SDRs. Created by the IMF way back in 1969 for that purpose, SDRs never caught on. While SDRs may be declared an official international reserve asset today, they are not likely to become the world’s key international currency anytime soon. In the meantime, countries in China’s current predicament--acquiring more dollars than they think prudent--could avoid such risks in the future by allowing their currencies to appreciate.Special drawing rights ; Bank of China

Owen F. Humpage

English

Research Papers in Economics

ECONOMIC COMMENTARY March 2009
Replacing the Dollar with Special Drawing 
Rights—Will It Work This Time?
Owen F. Humpage
The head of China’s central bank is calling for countries to replace the U.S. dollar as an international reserve currency 
with something called SDRs. Created by the IMF way back in 1969 for that purpose, SDRs never caught on. While SDRs 
may be declared an ofﬁ  cial international reserve asset today, they are not likely to become the world’s key international 
currency anytime soon. In the meantime, countries in China’s current predicament—acquiring more dollars than they 
think prudent—could avoid such risks in the future by allowing their currencies to appreciate.
  ISSN 0428-1276
Zhou Xiaochuan, Governor of the Bank of China, wants a 
new international reserve currency, one that is “disconnected 
from economic conditions and sovereign interests of any 
single country.” He claims that credit-based national reserve 
currencies, like the dollar, are inherently risky, facilitate 
global imbalances, and foster the spread of ﬁ  nancial crises, 
but China’s concerns may also be a bit more parochial. The 
country holds a huge portfolio of dollar-denominated assets 
that could incur valuation losses, if recent U.S. actions to 
limit ﬁ  nancial turmoil and stimulate the economy generate 
inﬂ  ation and dollar depreciation. 
The People’s Bank of China has offered a ﬁ  x to the dollar 
problem. They recommend supplanting the reserve-currency 
role of the U.S. dollar with Special Drawing Rights (SDRs), 
a composite currency issued by the International Monetary 
Fund (IMF). Others, including Nobel Prize winner Joseph 
Stiglitz and a U.N. panel of experts, have endorsed the idea. 
Adopting the SDR as an ofﬁ  cial international reserve asset 
may be technically feasible and it could conceivably occur 
fairly quickly, but substituting the SDR for the dollar more 
broadly as the world’s key international currency will not 
happen anytime soon. People reap substantial economies 
from conducting cross-border commerce in dollars, and until 
the SDR matches these beneﬁ  ts, central banks will still need 
dollars. In the interim, countries that want to limit their expo-
sure to credit-based reserve currencies, like the dollar, might 
simply allow their currencies to appreciate. 
Something Old, Something New
Complaints about the dollar and a fascination with SDRs are 
not new. The IMF created SDRs as an international reserve 
currency in the late 1960s to solve problems, similar to 
Dr. Zhou’s concerns, which rose out of the Bretton Woods 
ﬁ  xed-exchange-rate system. Although Bretton Woods was at its 
heart a gold-based currency arrangement, the U.S. dollar quick-
ly emerged as the key international currency, both for ﬁ  nancing 
international commerce and as an ofﬁ  cial reserve currency. 
Today, as during Bretton Woods, countries accumulate 
foreign exchange when they prevent or limit the appreciation 
of their currencies in the face of persistent trade surpluses 
and foreign ﬁ  nancial inﬂ  ows. Once acquired, ofﬁ  cial reserves 
then provide these countries with a buffer stock that they 
can draw down to mitigate the disruptive economic effects of 
unexpected trade shortfalls and temporary outﬂ  ows of foreign 
funds. Absent such reserves, these countries would either 
have to allow their currencies to depreciate or quickly tighten 
their monetary policies, but such abrupt adjustments could be 
disruptive and might not be compatible with these countries’ 
current goals for inﬂ  ation or real economic growth. At its 
heart, the desire to acquire and hold ofﬁ  cial foreign-exchange 
reserves reﬂ  ects a desire to prevent, or at least limit, exchange-
rate adjustments. 
About 15 years into the Bretton Woods era—just like today—
many countries began to view their holdings of ofﬁ  cial U.S. 
dollar reserves as excessive, and they worried that the United 
States might be forced to devalue the dollar. A dollar devalu-
ation would saddle these countries with foreign exchange 
losses, since a devalued dollar would buy less abroad. As the 
situation unfolded, some countries, led by France, sought to 
replace the dollar with a reserve currency unrelated to a single 
national currency, if not solely related to gold. The IMF—then 
the guardian of the Bretton Woods parity grid—came up with 
the SDR. The IMF initially deﬁ  ned the SDR in terms of a 
ﬁ  xed amount of gold, then equal to one dollar, and allocated 
9.3 billion SDRs between 1970 and 1972 to member countries 
in proportion to their quotas in the IMF. Before the SDRs 
0309.indd   1 5/26/2009   4:38:09 PMMany of the foreign-exchange transactions that are denomi-
nated and undertaken in dollars do not directly involve U.S. 
residents. A Japanese company looking to buy Brazilian 
coffee will face a dollar price and make payment in dollars. 
International trade in fairly standardized commodities, like 
oil, coffee, and grains, and in products that sell in highly 
competitive markets—including many ﬁ  nancial instruments—
is typically denominated in U.S. dollars. Invoicing in a single 
currency helps producers keep their prices in line with their 
competitors and simpliﬁ  es price comparisons across the dif-
ferent producers. Naturally, the gains of a single currency 
rise with the number of producers, since it simpliﬁ  es a wider 
range of price comparisons. 
In contrast, international trade in heterogeneous manufac-
tured goods, where pure price competition is not as crucial, 
tends to be denominated in the exporters’ currencies, but 
even in these cases importers—or their banks—will often 
acquire the exporters’ currencies by ﬁ  rst trading their home 
currencies for U.S. dollars and then trading U.S. dollars for 
the exporters’ currencies. The world has found signiﬁ  cant 
cost savings from these arrangements. 
The dollar has maintained this role over the years, despite 
substantial ﬂ  uctuations in its exchange value, because the 
size, sophistication, and relative stability of the U.S. economy 
generally render the costs of transacting in U.S. dollars lower 
than the costs of transacting in other currencies that do not 
equally share these characteristics. In large part, the wide-
spread use of the dollar developed and continued because the 
United States has been the largest, most broad-based exporter 
and importer in the world. With a lot of Americans trading 
globally, a lot of dollars will naturally change hands. As a 
consequence, traders must ﬁ  nance a large portion of their 
business in U.S. dollars, so they maintain accounts in dollars, 
seek loans in dollars, and undertake myriad other ﬁ  nancial 
arrangements in dollars. 
A strong and open U.S. ﬁ  nancial system helped facilitate the 
dollar’s international use. Of course, a high degree of feed-
back naturally exists between the dollar’s expanding role in 
trade and the growth of an accommodating ﬁ  nancial struc-
ture. Nevertheless, U.S. ﬁ  nancial markets have always been 
innovative and relatively free of cumbersome regulations. 
They offer many different types of ﬁ  nancial instruments 
and well-developed secondary markets, which enhances the 
liquidity of dollar-denominated assets. All this makes holding 
dollars convenient and transacting in dollars relatively easy. 
Moreover, as dollar trade expands, U.S. ﬁ  nancial markets 
grow and more and more foreign ﬁ  nancial ﬁ  rms—even ones 
not located in the United States—offer dollar-denominated 
products, further reducing the costs of transacting globally in 
dollars. 
even hit the shelf, however, President Nixon threw a wrench 
in the Bretton Woods works. He closed the U.S. gold win-
dow on August 15, 1971, refusing thereafter to convert dollar 
reserves into U.S. gold. Countries holding dollars were stuck. 
By March 1973, the large developed countries had all allowed 
their currencies to ﬂ  oat against the dollar, ending their need 
to acquire dollar reserves. 
With the advent of ﬂ  oating exchange rates, the IMF redeﬁ  ned 
the SDR as a weighted average of the U.S. dollar, the British 
pound, the Japanese yen, and the currencies that eventually 
comprised the euro. The dollar has the largest weight, cur-
rently about 40 percent, so changes in the dollar impact the 
SDRs more than similar changes in the pound, yen, or euro. 
Because of its construction, however, the SDR will likely be 
more stable relative to other currencies than the dollar; so, 
holding a portfolio of SDRs is liable to present a country with 
less exchange-rate valuation risk than holding dollars. 
While many in the late 1960s and early 1970s believed that the 
SDR would supplant reserve currencies and possibly even gold 
in ofﬁ  cial portfolios, the SDR basically died at birth. The IMF 
made a second allocation of 21.4 billion SDRs between 1979 
and 1981, again in proportion to member countries’ quotas, 
but the SDR quickly devolved for the most part into a unit of 
account, primarily on the IMF’s books, as the large developed 
countries accepted ﬂ  oating exchange rates as the norm. 
If countries are willing to allow their exchange rates to adjust 
freely to trade ﬂ  ows and to cross-border movements of ﬁ  nan-
cial funds, they do not need ofﬁ  cial foreign-exchange assets. 
Despite the widespread acceptance of ﬂ  oating exchange rates, 
however, no country—including the United States—has com-
pletely tossed out their portfolio of foreign-exchange reserves. 
They keep some around just in case they may sometimes 
want to support their exchange rates. In doing so, they accept 
that the exchange value of these reserves will ﬂ  uctuate from 
time to time. 
The Dollar
The reserve currency of choice is the dollar (ﬁ  gure 1). The 
IMF estimates that 64 percent of the world’s ofﬁ  cial foreign-
exchange reserves are held in dollar-denominated assets. 
The euro, the second most widely held international reserve 
currency, lags well behind, followed by the British pound and 
Japanese yen. These currencies’ rankings as ofﬁ  cial reserves 
parallel their status in international commerce more generally. 
This correlation should be of no surprise. Why hold a cur-
rency that no one uses? 
The dollar’s status as an ofﬁ  cial reserve currency reﬂ  ects its 
broader role as the key international currency. According to a 
2007 survey, roughly $3.2 trillion worth of foreign exchange 
trades hands each day, and 86 percent of those transactions 
involve dollars (ﬁ  gure 2). Again the euro is a distant second, 
with the British pound and Japanese yen trailing. 
0309.indd   2 5/26/2009   4:38:35 PM1. The Currency Composition of Reserve Holdings
Source:  International Monetary Fund,International Financial Statistics, COFER data.
2. Exchange Rate Pairs
Source: Bank for International Settlements, Triennial Central Bank Survey, 2007.
3. Foreign Exchange Reserves
Source: International Monetary Fund, International Financial Statistics.
U.S. dollars
64.0%
Euros
26.5%
British pounds
4.1%
Japanese yen
3.3%
All other
2.1%
U.S. dollar/
all other
34.4%
U.S. dollar/euro
27.3%
U.S. dollar/British pound
11.7%
U.S. dollar/
Japanese yen
12.9%
All others
4.0%
Euro/all other
9.7%
0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
1972 1976 1980 1984 1988 1992 1996 2000 2004
Trillions of U.S. dollars
Japan
China
Korea
India
Russia
As more and more people use dollars in international 
commerce—as the global network for dollars expands—the 
beneﬁ  ts of using the dollar in exchange rise. The network 
beneﬁ  ts of an international currency are much like the 
network beneﬁ  ts of a language. As more and more people 
across the globe learn to speak English—as compared to, say, 
Welsh—then learning English, instead of Welsh, is increas-
ingly valuable in terms of one’s ability to communicate. The 
process is self-reinforcing. 
Moreover, once the network beneﬁ  ts of a particular interna-
tional currency—or a language—become substantial, people are 
prone to continue using it, even if a viable competitor exists. 
Making the jump from the dollar to a new international 
currency, like the SDR or even the euro, requires everyone—
or at least a substantial proportion of people—to make the jump 
in close concert. Otherwise, the network beneﬁ  ts are lost. For 
that reason, the world is not likely to shift quickly away from 
dollars even if the SDRs become a new international-reserve 
option. 
Tipping Point 
Of course, persistently bad U.S. economic policy could 
push people into a new international currency. If foreigners 
suspected that the costs of holding dollars in terms of lost 
purchasing power would soon exceed the network beneﬁ  ts 
of transacting in dollars, they would migrate to an alternative 
international currency. To generate such an expectation, the 
Federal Reserve System would need to run a substantially 
higher inﬂ  ation rate than the rest of the world for a prolonged 
period of time. 
At its core, China’s SDR plan may reﬂ  ect such a concern. 
Since September 2008, the Federal Reserve System has under-
taken a $1.2 trillion expansion of its balance sheet, unprece-
dented in terms of size and the types of assets that the System 
has acquired. Other key central banks have responded simi-
larly. With the global economy currently in a deep recession, 
inﬂ  ation is not a present concern, but at some point—later this 
year by most accounts—the U.S. economy will stabilize and 
begin to reverse course, and the Federal Reserve will need 
to do likewise. The System will be doing so in the face of 
substantial federal budget deﬁ  cits, which are likely to exceed 
a whopping 6.4 percent of GDP by ﬁ  scal year 2011. To be 
sure, this unwinding will be challenging, but predictions of 
inﬂ  ation and dollar depreciation currently seem more akin 
to guesswork than forecast. The Federal Reserve successfully 
weathered similar storms in the 1980s. 
What’s a Country to Do? 
In the meantime, countries—like China—that are worried 
about their expanding dollar portfolios have another option: 
allow their currencies to appreciate. Countries acquire foreign-
exchange reserves when they limit the extent to which their 
currencies appreciate in the face of persistent trade surpluses 
and foreign ﬁ  nancial inﬂ  ows. 
0309.indd   3 5/26/2009   4:38:36 PMOwen F. Humpage is a senior economic advisor at the Federal Reserve Bank of Cleveland. The views he expresses here are his and not 
necessarily those of the Federal Reserve Bank of Cleveland or the Board of Governors of the Federal Reserve System or its staff.
Economic Commentary is published by the Research Department of the Federal Reserve Bank of Cleveland. To receive copies or be placed 
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China is a classic example. Between mid-1995 and mid-2005, 
the People’s Bank of China maintained a ﬁ  xed peg between its 
currency, the renminbi, and the U.S. dollar, by buying up the 
dollars rapidly ﬂ  owing into China through trade and invest-
ments. China’s foreign-exchange reserves—65 to 70 percent of 
which are in dollar-denominated assets—grew sharply (ﬁ  gure 3). 
Had the People’s Bank not bought up the dollars at the existing 
pegged value, the strong inﬂ  ow of dollars would have lowered 
the renminbi price of dollars—that is, the renminbi would have 
appreciated against the dollar. A renminbi appreciation would 
have reduced Chinese exports, encouraged Chinese imports, 
and slowed dollar inﬂ  ows. 
Between mid-2005 and mid-2008, the People’s Bank allowed the 
renminbi to appreciate 19 percent against the dollar, but China’s 
reserves continued their skyward trajectory, suggesting that the 
People’s Bank still limited the renminbi’s appreciation. Since then, 
the renminbi has remained little changed relative to the dollar. 
All this is ﬁ  ne—many countries see beneﬁ  ts in managing their 
exchange rates, particularly to avoid appreciations. Holding a 
foreign-exchange exposure, however, is simply the cost of doing so. 
Recommended Readings
Zhou Xiaochuan, “Reform the International Monetary System” 
People’s Bank of China, March 3, 2009. Available at http://www.
pbc.gov.cn/english/detail.asp?col=6500&id=178.
Bennett T. McCallum, “China, the U.S. Dollar, and SDRs.” 
Presentation at the Shadow Open Market Committee, April 24, 
2009, held at the Cato Institute, Washington, D. C.
0309.indd   4 5/26/2009   4:38:38 PM

Replacing the dollar with special drawing rights--will it work this time?

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Replacing the dollar with special drawing rights--will it work this time?

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