China’s yuan, or renminbi, is on the verge of joining the global currency elite. The IMF is expected to announce the yuan’s inclusion shortly. An announcement could come as early as Monday.
It’s a rather big deal. Inclusion into the so called Special Drawing Rights (SDRs) is of strategic importance to the Chinese. It elevates the renminbi into an exclusive club, marking the first change in the basket in 15 years.
Only four other currencies currently comprise the SDRs. The basket includes the US dollar, the euro, the British Pound and the Japanese yen. They don’t have an equal weighting however. The US dollar accounts for 42% of the basket whereas the yen accounts for just 9%.
Yet more important is what it means for China’s position in global finance. In a few years’ time, the world will need yuan reserves like never before.
It’s worth explaining briefly here what SDRs actually are. Not everyone is clear on why it matters so much.
SDRs are not, as you might imagine, a typical currency in the traditional sense. They’re not freely tradable. You can’t buy SDRs with Aussie dollars. Or any other currency for that matter. But its value derives from serving as an international reserve asset.
What does that mean? Take IMF loans as an example. The IMF values whatever it lends out in euros to Greece in SDRs for instance. That’s important as it minimises the risks associated with currency fluctuations.
Aside from this, membership also carries a diplomatic significance too. It gives China a greater say in global finance. And in the IMF too for that matter. Both are important from a strategic point of view as far as China is concerned.
Opposition to the yuan’s acceptance
It hasn’t all been smooth sailing for China. Its quest for SDR inclusion has been pitted with setbacks.
There’s been plenty of opposition to the yuan’s inclusion into the basket. The biggest sceptic, not surprisingly, has been the US. They’ve accused China of manipulating the value of the yuan on several occasions. The US still believes that China controls the yuan too tightly. And it thinks its markets are too closed off to qualify for SDR inclusion.
Yet China’s yuan devaluations in August drew as much support as it did criticism. It seems counter intuitive, but the IMF actually backed the devaluations. Even if it’s most important stakeholder, the US, didn’t… As the ABC reports, ‘[the IMF believes] it reinforced the currency’s movements with market forces and opened the door to future revaluation.’
In any case, China will get the nod, but it’ll be interesting to see how the US votes.
Ultimately, the US doesn’t have a problem with the yuan. US scepticism of the yuan boils down to weariness over China, period. As the world’s sole superpower, the US views China with suspicion.
Anything that increases China’s standing in the world is a problem for the US. It understands that China aspires to have a louder voice in international matters. And that these incremental moves only enhance that ambition.
Whether that’s justified or not isn’t the point. It’s just how the world works. China is a threat to US dominance, and Washington isn’t happy about that.
Yet the world can’t ignore China forever. At some point the US must start making concessions. It can’t hope to militarily, politically, and economically enclose China. If it wants to avoid conflict then it must give China breaks. Especially for an economy of China’s size and heft.
China’s economic rise over the past 30 years is nothing short of phenomenal. But its now shifting from an export led economy to a consumer driven one. It’s reached the point of maturity. And it’s ready to take on more global responsibility. The opening up of Chinese currency and financial markets will go a long way in achieving that.
Limits to SDR inclusion
There are also limits to what the SDR inclusion can do for China. In many ways, this is a move of political importance. It allows China to feel more confident about its role as a future global leader.
Yet the actual tangible benefits for China are less obvious. As ratings agency Fitch note, we won’t see huge demand for renminbi reserves in the short term. Not that China cares about that. It’s waited long enough for inclusion. It can wait a bit longer. For the Chinese this is a long term play. It’s a critical starting point for the yuan’s rise, which is all that matters.
Keep in mind though the SDR inclusion won’t come into effect for a while. When China gets the nod, the yuan won’t officially enter the SDR basket until September 30, 2016.
Once it does though, the yuan should gain major credibility in global finance. Over the coming decade, we’re going to see international reserves of the yuan rise exponentially. It’ll liberalise China’s capital accounts. And that will open up China’s financial services to the rest of the world.
It’s all part of the great shift towards the emergence of a new superpower.
The shift away from the US dollar
There’s another reason why the US is worried about the rise of the yuan.
The yuan’s acceptance into the SDR is a shift towards a new global reserve currency. One that supplants the position the US dollar currently enjoys.
The importance of such a transition in global finance can’t be understated. It would spell the end of the US dollar’s 70 year reign as the reserve currency. And it raises serious concerns about how this changeover plays out. Will the US accept this transition? Or will it do everything in its power to thwart it? Considering what’s at stake, you’d bet on the latter.
The US remains the world’s biggest economy. You can’t trade on global markets without holding US dollar reserves. That allows the US government to spend in excess of what it earns. And it’s allowed it to build up an incredible amount of debt, standing at well over US$15 trillion.
Should it lose its reserve currency status, it’ll limit how far the US can accumulate debt.
Now, the dollar replacement won’t be the yuan. But it might be the SDR. Or at least something that resembles a basket of currencies. So the weighting of any such basket will remain important. But for the US, the dollar will go from having 100% control, to less than half. That’s not a great outcome for the US, however you dress it up.
The inclusion of the yuan is an historic moment. It’s the clearest signal yet that China’s assuming a major position in global finance. One can only hope the transition goes smoothly.
Contributor, The Daily Reckoning
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