INTRODUCTION TO SDR (SPECIAL DRAWING RIGHTS) SDR serves as a supplementary reserve asset and unit of account for IMF

F and some international organization. It means four classic properties: 1. A medium of exchange:

The SDR has a very limited role as a medium of exchange. Official SDRs can be created only through an allocation or issuance by the Fund to meet the long-term global need . . . to supplement existing reserve assets, and the stock can be reduced only through a cancellation by the Fund. Once created, these assets can be used only in specified transactions involving the Fund, its member countries, and a short list of other prescribed holders.
2. Unit of account (as paper gold):

The SDR and the dollar were initially equal in value, but when the dollar was devalued against gold and against other major currencies, the SDR retained its nominal gold value: hence its reputation as paper gold.
3. Store of value:

As a store of value for a member country, the SDR is the equivalent of foreign Exchange reserves. This is really the heart of the issue. An allocation of SDRs by the IMF provides each recipient (a participating member country) with an unconditional and costless line of credit, on which the holder neither earns nor pays interest.
4. Standard of value:

As a standard of value, the SDR can serve both as a peg for a countrys Exchange rate and a means of denominating contracts and other obligations.

MAKING SENSE OF SDR SDR was created in 1969 and currently stands at 204.61 billion Its value based on four base currencies Its is not denominated in notes and coins but it plays important role in interest bearing reserve international assets The IMF allocates the SDR as per standing of the country in the organization i.e. countries share in global GDP wherein members can exchange between each other but cannot be used directly to buy any goods or services Member countries can exchange SDR for hard currencies like dollars, yen, pounds or euro voluntarily between member countries If the reserves of SDR is more from the allocation for particular member countries they would earn interest and if it is less from the allocation have to pay interest for the shortfall

Why it could replace the dollar The great thing about the SDR is that it is not dependent on any one economy for its value. Because of the SDRs "global value," the risk of exchange rate swings in global trade is greatly reduced. The SDR unit, for example, could be used to easily set prices in global trade, denominate financial assets, peg currencies, and keep a very uniform account of statistics. The SDR has also garnered a lot of support from China and Russia in the past. Both countries expressed their concern over the falling value of the dollar, and wanted to have a currency that is more stable. Why it can't replace the dollar The main problem with the SDR is that the institution that issues it, the IMF, is not a bank. This implies that the IMF can ONLY lend and provide SDRs to governments and NOT to private markets. Using SDRs to buy anything in the private market involves a lot of time and expense because you first need to convert them back to the domestic currencies. References: http://www.babypips.com/blogs/piponomics/3-alternatives-to-the-us-dollar.html http://www.imf.org/external/pubs/ft/history/2001/ch18.pdf http://www.imf.org/external/about/sdr.htm IMF FACTSHEET PDF