China Gets Its Reserve Currency Status

THE INTERNATIONAL MONETARY Fund’s executive board has, as expected, approved the inclusion of the yuan in the basket of currencies that constitute its Special Drawing Rights. Thus, China joins the dollar, euro, yen and pound sterling in the elite club of reserve currencies, as Beijing has long been so desirous of doing.

The yuan’s weight in the basket will be 10.9%, slightly less than had been expected but still sufficient to rank it ahead of the yen (8.3%) and sterling (8.1%), if a ways behind the dollar (41.7%) and the euro (31%).  The dollar’s weighting will remain unchanged: the yuan’s allocation has all been taken from the three other currencies. The new status takes effect from October 1, 2016.

The decision is largely symbolic at this point in the yuan’s international usage, but marks a milestone in the currency’s internationalization — and more significantly its full convertibility. ‘Freely usable’ is an IMF criterion for a currency’s inclusion in its basket.

As we have noted before, the contingent opening of the capital account is also an important policy priority for rebalancing the economy. The IMF’s accolade will be a boost for those in China who have been promoting that, and especially now as other economic-rebalancing reforms are flagging in the face of slowing growth and political opposition.

Christine Lagarde, the IMF’s managing director, said the decision was:

a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems. The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy.

As she could have been expected to say. However, the IMF’s announcement also included this kicker:

Authorities of all currencies represented in the SDR basket, which now includes the Chinese authorities, are expected to maintain a policy framework that facilitates operations for the IMF, its membership and other SDR users in their currencies.

i.e., no backsliding of financial reform whatever the domestic temptations.

Yuan Marches On Towards Reserve Currency Status

THE INTERNATIONAL MONETARY Fund’s staff have recommended that the fund includes the yuan in the basket of currencies that constitute its Special Drawing Rights. The IMF’s board is likely to endorse the staff’s view at its November 30 meeting, agreeing that the currency meets the test of being ‘freely available’, a test that it failed in 2010 when the IMF last reviewed its basket. The yuan would then become a reserve currency from September 2016.

The staff recommendation is not unexpected, but it marks another milestone in the Chinese currency’s internationalization — and more significantly its full convertibility. As we have noted before, the contingent opening of the capital account is an important policy priority for rebalancing the economy.

Recent changes to that end, but also to address specific IMF concerns, have included overhauling how the central bank sets its reference rate for the currency in foreign-exchange markets, letting foreign central banks trade China’s onshore currency products and improving the short-term yield curve through the issuance of  three-month debt.

The People’s Bank of China said in a statement that it welcomed the IMF staff’s recommendation, trotting out that making the yuan a reserve currency would be “a win-win result for China and the world” and avowing its commitment to financial reform and opening-up.

None of that makes pushing ahead with either any less urgent, or any easier.

China Takes More Small Steps Towards Yuan Convertability.

The widening of the daily band within which the yuan can trade against the U.S. dollar is another small step towards making the currency convertible. The timing of the announcement by the People’s Bank of China that the band will be widened to 1% from 0.5% was no accident. It came just ahead of the IMF and G-20 meetings in Washington, where Beijing is usually criticized for keeping its currency undervalued. Announcements intended to draw some of the sting from such criticisms is not uncommon on Beijing’s part.

Yet nor should this latest one be unexpected. The current five-year plan sets expanding the use of the yuan in cross-border trade and investment as a goal, as it does the widening of the capital account, the two going hand-in-hand. The latest announcement also follows in increase in the quota of Chinese stocks and bonds foreign investors can buy, a raising of the ceiling on offshore yuan that can be invested domestically, and, as part of the Wenzhou experiment, the ability of Chinese investors to put excess savings abroad.

The yuan has risen by almost a third since its hard peg to the dollar was broken in 2005 and by 8.3% since 2010 when a temporary peg imposed after the 2008 global financial crisis was removed. Prime Minister Wen Jiabao has recently talked of the currency nearing equilibrium with the dollar. Not all China’s trading partners agree, particularly China bashers in the U.S. who say that Beijing keeps its currency undervalued to protect its exporters. Reminder to protectionists: currency movements can be driven by investment as well as trade flows. If more investment moves offshore from China as a result of loosening currency controls, then the yuan may fall against the dollar, not rise as its critics clamor for. The new trading band gives it room to move either way in response to market demand.

Criticism of China’s exchange-rate policy looks increasingly out of date. The battle is no longer only over exports. The longer war is over which currency will become the world’s dominant one, the dollar or the yuan. The yuan has to become fully convertible first. Though it still has a long way to go even to challenge the dollar let alone eclipse it, this latest round of currency-control loosening takes it another few steps down that path.

China: One Currency; Two Yuans

London has made more than one fortune on the China trade, though they have not all ended happily. Whether the yuan will end up as the new opium is the question raised by George Osborne, Chancellor of the Exchequer as the U.K. calls its finance minister, who has been in Hong Kong to promote a scheme to make London the leading international center for trading in China’s currency. London and Hong Kong have been talking about how to do this since last summer. Osborne’s trip will continue the talks.

Chatham House, a think tank in London, has forecast that trade transactions settle in the currency would reach the equivalent of $1 trillion by 2020. Yet, while Beijing has been taking baby steps towards making the yuan a fully convertible currency, there is still a long, long way to go. It remains an aspiration as much as anything but also a hostage to the pace of financial reform, which, as we have noted before, is in stasis during the leadership transition. China may need to rebalance its economy away from export- and investment-led growth and towards domestic consumption, for which financial system reform is a necessary if not sufficient condition, but vested political interests stand in the way. For all the wishful thinking in some parts, the Chinese currency is far from displacing the dollar as the world’s reserve currency, or even having the standing of the yen or the euro in such circles.

If anything, the surprise is that the offshore market for yuan is as large as it is (yuan deposits in Hong Kong total the equivalent of $80 billion). Normally the deepening and development of domestic financial markets and the easing of capital controls is prelude not postscript. In China, the first two are so difficult that the third is the easier option, even if by having a government controlled onshore yuan market in China and market driven offshore yuan market in Hong Kong and London, China may well end up, not untypically, with one currency but two yuans.

London, of course, will be happy to take its skim off both.

Zhou Bangs On About The SDR As World Currency

The People’s Bank of China has found a drum and continues to beat it. In its annual financial stability report, the central bank again calls for a super-sovereign currency to replace the dollar. The bank’s head, Zhou Xiaochuan, has been a cheerleader for this course of action, and caused a stir earlier this year when he said the dollar could eventually be replaced as the world’s main reserve currency. As well as using the SDR in that role, the PBOC report recommends that the International Monetary Fund  manage a portion of its member countries’  foreign reserves.

We heard a similar thumpty-tee-thump ahead of the BRICs summit in Yekaterinburg earlier this month, though in the event not much policy to that end. China feels acutely the weak dollar’s diminishing of its large and largely dollar-denominated foreign exchange reserves (though it would face a similar problem under an SDR regime if it continued to run huge surpluses). However, the  PBOC has the luxury of seeing the policy remedy to its current dollar bugbear through a purely economic lens, without the realpolitik filter the top Party leadership must employ. (Yves Smith has more detailed discussion of the economics at Naked Capitalism).

BRICs and Brickbats Over The Dollar’s Reserve Currency Role

Brazil, Russia, India and China meet on Tuesday in Yekaterinburg for the first summit of the so-called BRICs, the four leading emerging economies.

They see themselves as a leading voice for the developing world and as a counterweight to the developed world’s dominance in international economic matters as represented by the G-7. As such they want to want to boost their role as global players and increase their collective weight in international organizations.

So far, they share too little in common beyond large, fast growing developing economies to have acted as a bloc. One arena in which they might have been expected to exert collective clout and to speak as one for the developing world was the seemingly interminable Doha round of world trade talks. Yet the interests of China’s low-tech farmers were different from those of their Indian counterparts and far too different from those of Brazil’s high-tech farmers for there to be any unity.

There is one issue that is emerging, however, on which they could speak with a common voice, and it is one on which Beijing has already been a herald: the challenge to the role of the dollar  as the world’s sole reserve currency. Beyond the statistics commonly trotted out to describe the BRICs — they cover a quarter of the world’s land surface, are home to 40% of the world’s people and account for 15% of world GDP– is one highly relevant to this issue: they hold 42% of global foreign exchange reserves.

As well as giving repeated airings to its concerns about the falling value of the dollar on all the U.S. debt it owns, Beijing has switched $50 billion of its admittedly more than $1 trillion of reserves into multi-currency based bonds issued by the International Monetary Fund. Russia has moved $10 billion and Brazil’s central bank has just announced it is doing the same with a similar amount of its reserves. The BRICs want more say over the IMF and are putting a bit of the money at least where their mouths are, and Beijing in particular would be most pleased for the IMF emerge as more of a counterweight in the global financial system to the U.S. The issue will figure prominently at the meeting in Yekaterinburg, a town historically redolent of executing the old order.

China Mulls A New Long-Term Alternative To The Dollar

Another straw in the wind that China’s central bankers are toying with the idea of an alternative to the dollar as the global reserve currency: Hu Xiaolian, director of the State Administration of Foreign Exchange (SAFE) and a central bank vice governor, says that the IMF could raise funds quickly by issuing bonds, and that China “would actively consider” purchasing such debt.

Any purchases would presumably be funded by swapping out of China’s large holdings of U.S. Treasuries ($1.95 trillion at end-2008). Recently, Prime Minister Wen Jiabao expressed concern about the safety of U.S. Treasuries, although China has little alternative at this point for recycling its trade surplus (as both he and Hu acknowledge).

Hu’s remarks follow those by central bank Governor Zhou Xiaochuan that the IMF should aim in the long term to create a non-sovereign reserve currency, and those of Russian officials who say that China is one of the nations backed its call for a discussion on how to replace the dollar as the world’s primary reserve currency.

The Fund already has a currency of sorts in its special drawing rights, but Zhou would have something more tradable in mind. IMF bonds would be a step in that direction as well as letting China respond to international calls for it to boost its financial support for the IMF so the Fund can provide more money to nations hard hit by the global financial crisis.

Dollar-Bound

Even with a slowing economy and export markets slowing faster, China has a lot of trade surplus dollars to recycle. Its foreign-exchange reserves are in excess of $1 trillion and they sit mostly in U.S. dollar-denominated assets.

The American currency depreciated steadily for the past four years, though it has rallied recently. This may be a technical rally due to a rare combination of unwinding of derivative positions at a time when shorting the dollar is nigh impossible because of the lack of liquidity; though the flight-to-quality rally school will remind you that, though counterintuitive, there is precedent for the dollar to rise during recessions.

Regardless, the losses on China’s dollar-denominated assets have grated with some officials. So has the fact that China has been subsidizing what is now seen as American extravagance and a broken U.S. financial system — while all the while being lectured about how China’s markets should become more like the U.S.’s; schadenfreude alert.

China has started to diversify its foreign-currency holdings, though that has perils of its own as some of the recent foreign exchange losses by Chinese companies have shown (see:”Two More Chinese Firms Reveal Forex Losses“) And more trade in recent years has been denominated in currencies other than the dollar, such as oil in euros. A lot of oil producers would be happy to undermine dollar hegemony, and a world where the dollar shares trade shelf space, so to speak, with the euro and the yen looks more like the multipolar world of the global economy.

But there is no substantive alternative to the U.S. dollar as the world’s default reserve currency. Neither the Europeans nor the Japanese want it. Nor can the renminbi, still not fully convertible, aspire to the role.

The notion of creating a non-national global reserve currency has been floated many times before, and will no doubt be giving another airing during the forthcoming run of proposed world leaders’ summits on the financial crisis and a new regulatory regime.

There was some corridor chatter about the idea at the Asia-Europe summit in Beijing at the end of last week. But it would be a brave punter who bet on it coming about. Indeed, the substantive move to come out of the summit on this front was a Chinese-Japanese agreement to support the dollar jointly. They just can’t afford otherwise.