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Depending on where you get your news today, you’re either entirely apathetic or cautiously suspicious of the International Monetary Fund’s decision to begin adding the Chinese Yuan (renminbi) to the Special Drawing Rights (SDR/XDR) basket in October of 2016. There’s likely room for both feelings with regard to today’s announcement.
First, before we dive into the potential issues with the IMF’s SDR changes, we need to talk about what the SDR is, and the current drawn-on currencies. Before the addition of the Yuan (CNY), the SDR was comprised of the United States Dollar (USD), the British Pound (GBP), the Euro (EUR), and the Japanese Yen (JPY). The SDR, itself is not a currency, but more of an exchange token to provide liquidity for countries when they are in positions of financial distress.
The legitimacy of these SDR tokens is backed by the respective value of the economies whose currencies are represented in the SDR. The logic for SDR from an international perspective makes sense: pegging the IMF’s relief efforts to one nation’s currency is a dubious proposition. For example, if the Federal Reserve were to content itself with a more conservative monetary policy and shrink the overall pool of dollars worldwide, the relative ability of the IMF to provide liquidity for developing countries would be systematically reduced.
The relative share of the SDR (the weight in the basket, as it were) before the CNY addition was: 41.9 USD, 37.4 EUR, 9.4 JPY and 11.3 GBP. The new makeup will be: 41.73 USD, 30.93 EUR, 10.92 CNY, 8.33 JPY, and 8.09 GBP.
As you can see from these new numbers, the October 2016 basket will be relatively unchanged with respect to the United States’ role. The major decline is the 6.47 drop in the Euro’s percentage.
It’s important to note that most folks expected this move by the IMF. Generally, inclusion in the SDR, as you can see from the other nations represented, denotes particular long-term economic growth and stability in the national economies represented.
Could the CNY-SDR affiliation mean that developing nations and nations in economic distress may begin to exchange SDR for CNY instead of USD? This is one of the more interesting points that some folks are making about the reason that today’s move should be concerning to the United States. If the loosening of the Central Party’s grip on the Yuan continues (as was required for the CNY to be an SDR currency), then you can expect to see the Yuan extend its influence in countries where Western sanctions prevent the banking exchanges of USD and other Western currencies. Yes, the legitimacy of CNY as a worldwide legitimate currency could see a banking boom in China.
The big problem with the train of thought that sees some kind of imminent movement away from the USD-centered banking establishment and to one based in the Yuan is that the current political realities of China still will prevent high-level investment. As we have already seen this year with the market volatility in China, the Central Party is unwilling to give up additional political and economic controls with respect to the Chinese markets.
But what about a Chinese currency crisis? Rather than some Sino-phobia about the creeping intersection of Chinese currency in world markets, I would be more concerned about what a destabilization event in the Chinese market could do to world currencies. We are all well-aware that China is a global leader from both a production and growth perspective. While I still have grave concerns that the Central Party has taken steps this year in order to avert a market panic that has only kicked the proverbial can down the road, China’s economy does continue to grow. The IMF vote today is a pat-on-the-back for some of the nuanced institutional controls that the Central Party has allowed to lapse on the Yuan. However, we are well-aware that the Yuan is under-valued (Donald Trump labelled the Chinese as currency manipulators). Regardless of the terminology, of the nations that are currently represented in the SDR, China will be the only one whose government has direct market-control over the price of currency.
Rather than worry about the IMF’s decision to reward some Chinese liberalization in monetary policy, if one wants to be concerned about the economic rise of China, the appropriate response is a look at the amount of USD held by the Chinese government ($3.65T). The Stratfor assessment from earlier this year summed up the currency issue in the larger context of internal conflicts and corruption within Beijing.
My personal concern comes in the form of a perceived rout in the Caixin’s Purchasing Manager’s Index in the summer of 2015 to its lowest point in over five years. While the Chinese economy still is showing ~7% growth per quarter, this is certainly coming off of the highs for the decade. Monetary reforms and the loosening of currency restrictions may act to stave off immediate impacts caused by manufacturing stagnation, but without real reforms, we can see that a continued Chinese boom may not be in the cards (certainly in the context of the immense growth rate in India).
To conclude: no, there’s probably no reason to be worried about the IMF’s decision to add CNY to the SDR. However, it is a vote of confidence (or at least legitimacy) for the Chinese growth over the past decade. We can also conclude that this is a major political win for President Xi who has been pushing for this kind of legitimacy for China for years.