The staff of the International Monetary Fund (IMF) has recommended that the yuan be included in the institution’s SDR basket. We wrote back in October:
SDRs were created under the auspices of the International Monetary Fund in 1969, before the post-war Bretton Woods monetary system collapsed. As world trade expanded, there was a shortage of gold and U.S. Dollars adequate to the need for reserve assets in an expanding financial system; SDRs were intended to fill the gap. The collapse of Bretton Woods, the end of the gold standard, the rise of floating exchange rates, and the increasing robustness of international capital markets reduced the significance of the SDR. It’s now backed by a ‘basket’ of major global currencies -- the U.S. Dollar, the British Pound, the Japanese Yen, and the Euro (heavily weighted to the Dollar and the Euro). Holders of SDRs can use them to obtain the currency of any IMF member state. Not very important in the nuts and bolts of global trade -- but still important as a sign of a currency’s reserve status.
The IMF’s board is very likely to accept the recommendation, so the yuan will now be included in the basket. What does it mean?
Really, it means very little. Alarmists in some circles may present it as another step in the inexorable march of the yuan toward world reserve currency status and its concomitant displacement of the U.S. dollar.
That view, however, is inaccurate. While SDR inclusion is a step forward for the yuan, it’s a relatively small one. In order for the yuan to become a world reserve currency, China would have to relinquish its tight control of capital flows and balance of payments; it would have to have an open banking system integrated with global financial markets, and would have to greatly change the issuance, clearing mechanics, and trading of Chinese government debt. For now, that prospect is an extremely distant one, simply because the Chinese authorities have no interest in making the changes that would be necessary for it to become a reality. To make those changes would remove from their hands some of the primary levers by which they exercise control over the Chinese economy. Are they likely to do that as they attempt to engineer China’s epochal shift from being the “world’s workshop” to being the world’s largest domestic consumer market? No. As we have noted many times, Xi Jinping is a reformist -- but he is a reformist who values stability above almost all else, and in all his reforms has sought to strengthen, not to weaken, Communist Party rule in China.
So do you need to worry about the yuan encroaching on King dollar? Not now, and not in the near future.
Investment implications: The Chinese yuan is set to be included in the International Monetary Fund’s SDR basket. Does it mean anything? It’s a symbolic step for the yuan, but any talk of the yuan’s achieving status as a global reserve currency is premature. Before that could happen, the Chinese authorities would need to integrate into the global financial system -- something they will not do while they still use China’s own financial system as one of their primary levers of control over the domestic economy.