Prior to Monday, the International Monetary Fund (IMF) recognized only the US dollar, the euro, the Japanese yen and the British pound as “reserve” currencies. Reserve currencies are those designated for transactions between central banks and the IMF, and are used to decide the currency mix that countries like Greece receives when the IMF provides financial aid.
The last change to the IMF’s basket of reserve currencies was in 2000 when the euro replaced the German mark and the Swiss franc. But that changed on Monday when the IMF decided to anoint the Chinese yuan (also called the “renminbi”) as a reserve currency, despite significant international pressure not to do so.
I’m writing about this today because the mainstream media has largely ignored this historic event. The move to elevate the yuan to reserve status came as a surprise to many since the Chinese government unexpectedly devalued the yuan twice this year. Perhaps that’s why the IMF delayed the inclusion of the yuan until October 1, 2016.
Those who oppose elevating China’s currency to reserve status most often cite China’s continued human rights violations and the fact that it remains a communist dictatorship as reasons for not granting it reserve currency status, which has long been a goal of the Chinese government.
The head of the IMF, Christine Lagarde, said it was “an important milestone in the integration of the Chinese economy into the global financial system.” She added it was also recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems (yada,yada,yada).
The yuan will now make up part of the IMF’s “Special Drawing Rights” (SDRs) – an asset created by the IMF which serves as a currency among IMF members. SDRs may only be exchanged for US dollars, euros, yen, pounds – or Chinese yuan beginning next October.
So what are the benefits to China of being anointed into this elite group of currencies? Some say the move is purely symbolic. However, if the yuan’s elevated status leads to more being held by central banks and businesses around the world – as it will – it would be helpful for their government’s finances.
Put differently, reserve currency status will make it much easier to sell Chinese government bonds. Some would argue that is not a good thing, and I might be among them. In any event, this explains why Chinese officials have made a concerted effort in recent years to build support for the yuan’s inclusion by the IMF.
To put the latest decision by the IMF to elevate the yuan to reserve currency status into perspective, we need to understand the weighting the Chinese currency will have in proportion to the others. The following chart shows this:
The Chinese yuan is set to have only about an 11% weighting in the SDR when it is added late next year. This should calm any concerns that the yuan could become the dominant currency for world trade anytime soon. Meanwhile, the US dollar’s weighting will be reduced by a miniscule amount, from 41.9% to 41.7%.
Apparently, the euro countries and Japan and Great Britain don’t mind that their weightings took the brunt of reduction to make room for China. So much for all the pundits predicting the death of the dollar when the yuan gained official reserve status.
The yuan accounts for a mere 2% of global payments and foreign exchange payments. Whereas the US dollar accounts for 45% of global payments and a whopping 87% of foreign exchange transactions.
While you may be hearing warnings from the usual crowd that the US dollar is going to collapse, or that it will be overtaken as the world’s reserve currency, such fears are overblown.
While I can’t say that I welcome China’s admission to the IMF as one of the reserve currencies, I don’t believe it’s a really big deal.
Obviously, China is the big winner in this deal, which it doesn’t deserve, in my opinion. The biggest loser in this deal is likely to be the euro, which for many reasons other than China, may not exist in another 10 or 20 years. That’s a discussion for another time.
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