12 December 2015
After being denied inclusion in the *SDR (Special Drawing Rights) during the 2010 review, China ambitiously sought inclusion again. In a bold move, the IMF announced on November 30th, 2015, that the Chinese yuan will get to join the SDR on October 1, 2016. The yuan will join the likes of the U.S. Dollar, euro, British pound, and the Japanese yen.
*The SDR was created by the IMF in 1969 as a supplementary international reserve asset, in the context of the Bretton Woods fixed exchange rate system. A country participating in this system needed official reserves—government or central bank holdings of gold and widely accepted foreign currencies—that could be used to purchase the domestic currency in foreign exchange markets, as required to maintain its exchange rate. But the international supply of two key reserve assets—gold and the U.S. dollar—proved inadequate for supporting the expansion of world trade and financial flows that was taking place. Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF
Only a few years after the creation of the SDR, the Bretton Woods system collapsed and the major currencies shifted to floating exchange rate regimes. Subsequently, the growth in international capital markets facilitated borrowing by creditworthy governments and many countries accumulated significant amounts of international reserves. These developments lessened the reliance on the SDR as a global reserve asset. However, more recently, the 2009 SDR allocations totaling SDR 182.6 billion played a critical role in providing liquidity to the global economic system and supplementing member countries’ official reserves amid the global financial crisis.
The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR serves as the unit of account of the IMF and some other international organizations. (www.imf.org)
Because of China's new place at the table of the SDR starting in 2016, it could make up 10% of the world's $12 trillion in government currency reserves. Not as much as the U.S. Dollar or Euro, but more than the Japanese yen and British pound as you can see in the table below from www.zerohedge.com.
For those that are reading this and thinking it's not a big deal; for those that underestimate China as an economic power because it's been said that China's success has been based on currency manipulation, keep these two things in mind. To begin with, China is now the world's leading exporter. Secondly, It is the world's second largest economy! The IMF placing the yuan in the SDR bucket means that the major players and powers in world economics has some confidence in Chinese economics. It also means, more importantly, that this move by the IMF puts the yuan in place to be a major reserve currency asset.
The news in the market today was very strange! Earlier in the day, Bloomberg made an announcement from Dow Jones news that said "China's Central Bank Signal Intentions to Loosen Yuan's *Peg To The Dollar". The market dropped by 200 points (1%), and continued to drop throughout the day, closing down 309.54 points (1.76%).
*DEFINITION of 'Currency Peg' A country or government's exchange-rate policy of pegging the central bank's rate of exchange to another country's currency. Currency has sometimes also been pegged to the price of gold. Also known as a "fixed exchange rate" or "pegged exchange rate." (www.investopedia.com)
Then all of a sudden, the conversation about the volatility in the market today shifted to the tanking in oil prices, and the scare about the possible upcoming fed rate hike next week (most experts say that there is a 74% chance for a hike). I'm in total agreement that these pieces of news together persuaded those substantial sell offs today, however, we can not continue to overlook China and it's place in the economic world.
If you've noticed, there was plenty of talk earlier on about currency manipulation in China: if you have continued to notice, there has not been much talk about that lately. That's because many are starting to understand that China wants it's currency to rise along with steady capital coming out of the country. This is in sync with it's international and domestic goals which all point towards the ultimate goal. A stronger yuan!
Loosening the yuan's peg to the dollar can mean a number of things to China, but I believe the ultimate meaning behind this is to eventually one day establish the Chinese yuan as the U.S. Dollar is today: THE world reserve currency! Instead of measuring the yuan against the dollar, China could very well want the dollar measuring itself against the yuan. This would place them at the top of the food chain: the number one economic power with the currency that all currencies measure themselves by.
I couldn't help but think, "why did the conversation become less and less about China's possible de-pegging and more about other areas of market influence?" Maybe the economic gurus know that 2016 could be the year of the dragon: the start of a time in history where the world economy began to shift, establishing a new regime! A new number 1!
