China is now officially part of the money major leagues. The International Monetary Fund has agreed to add the Chinese yuan to its basket of reserve currencies, where it will join the U.S. Dollar, the Euro, the Yen, and the British pound. The move will take place in October, 2016.
Inclusion is a highly coveted sign of respect for the Chinese currency — and also for the country’s economy and its political leaders. The last major currency to be included was the Euro, when it was created in 1999. The move stands as proof that China’s currency is responsibly managed, reasonably freely traded, and representative of a more open economy.
There’s more than pride involved here. The inclusion of the Chinese currency means that other countries are now more likely to hold their “reserves” in the yuan, as well as in dollars or euros. And the many Asian countries that trade with China will be less likely to handle their transactions in dollars, now that the yuan has this recognition as a significant global currency.
Few people alive today remember when the British pound reigned supreme among all currencies. (And when the British empire ruled the world.) In our lifetimes, the dollar has always been the currency in which most trade was priced, just as America was the world’s economic superpower. This move by the IMF to acknowledge the yuan could be the start of trade supremacy for the Chinese economy, and their currency.
What is the SDR?
The SDR or “special drawing right” was created by the IMF in 1969, as a way of balancing the then-fixed exchange rates that prevailed. But in the early 1970s, currencies started to trade freely against each other, reflecting the perceived “value” of the currency — the potential for inflation to cause the value to decline or the potential for economic growth or stability to put a currency in greater demand. (That is how we get today’s “strong dollar.”)
The SDR is not a currency. Rather it is a sort of international asset “reserve” created by the International Monetary Fund. As major countries “contribute” to the IMF, they are allotted these SDRs — which can then be exchanged for the other currencies that make up the basket. Think of it as a global banking and lending system unto itself. You’ll often hear that the IMF is making a loan to a troubled nation. That “loan” is an accounting item, made possible by member contributions to the IMF.
American Policy Toward China
It’s notable that the American government supported the decision to include the yuan in the SDR basket. Not to acknowledge the growing economic power of China would be futile. The have loaned us more than $1 trillion, by purchasing our debt in the form of Treasury IOUs. They are our second largest trading partner (after Canada). And they have, over the past few years, linked their currency fairly closely to the U.S. dollar.
And this decision is a warning to politicians in this election year that they should not try to make China the scapegoat for our own economic failures. As noted in this column in recent months, the Chinese have not been playing the currency devaluation game — as many other countries have done. They have not tried to make their yuan cheaper, to make their exports more attractive to the U.S. and boost their economic growth. In fact, the yuan has fallen only about 6 percent against the dollar over the past year, while the Canadian dollar has dropped more than 25 percent!
China currently allows its currency to fall (or rise) only 3 percent from a trading band set by the People’s Bank of China. They have done this to make sure their currency earned the respect of their trading partners in the West — even though the linkage to the dollar made China’s exports more expensive.
But now, with inclusion in the IMF SDR basket, China can use its growing economic power to let its currency compete more freely with other global currencies. Can you foresee a time when you might want to convert your savings from dollars to yuan — either to gain a better rate of return, or because you could make better growth investments there than here?
I hope that will not be the case. But this global signal of respect for China’s economy should cause the United States to think about changing our tax and regulatory policies to stimulate our own growth. We can’t take the dollar for granted forever. And that’s The Savage Truth.