International liquidity is the amount of money available for dealing with international economic transactions. Countries have reserves of gold and foreign currencies and use these for setting up international industries.
A nation’s international reserves are made up of gold, convertible foreign currencies and its automatic drawing rights with the International Monetary Fund (IMF). These reserves are necessary in order to finance its foreign trade and to deal with any temporary imbalance in the trade. There have been some concern that total reserves of convertible currencies, gold, and IMF drawing rights (i.e. international liquidity) may become inadequate to support the size of imbalance which will arise at the newer, higher levels of world trade.
In order to meet the demand for more liquidity, the IMF, has on several occasions increased the level of members quotas, but the supply of international liquidity, as a proportion of world imports has fallen by more than 50% since the early 70s. This situation has led the IMF to create an entirely new reserve asset in the form of special drawing rights. The scheme became operational on 1st January, 1970.
Special Drawing Rights (SDR) have been described as “paper gold” since a unit of SDR is defined as a certain quantity of gold. In fact, they are simply claims or rights which are honoured by members of the IMF, and by the IMF itself.
Members of the scheme may use SDRs to purchase or exchange other members’ currencies. Nations which have strong balance of payments positions may be designated to receive other member’s SDRs in exchange for convertible currencies, but they cannot be obliged to accept more than twice the amounts of their own allocations of SDRs. The incentive to accept SDRs from another member lies in the fact that they will be gold guaranteed and carry an interest payment.