With all of the upheaval on its stock market and hand-wringing over the consistency of its currency's value, China has nonetheless pushed forward with a two-pronged plan to shore up its financial system. Through a consistent program of adding gold to its reserves and following the prescriptions of the International Monetary Fund (IMF), it seems that the Chinese yuan is set to be added to the Fund's Special Drawing Rights (SDR), effectively giving the yuan (aka renminbi) de facto reserve currency status.
The IMF meets today and is expected to make the yuan/renminbi the fifth member of the SDR weighting, which is valued based on a basket of the most-used currencies worldwide.
Let's take a look at why the yuan appears headed for an elevated status.
Beginning this year, China started reporting additions to its gold reserves on a monthly basis after keeping the world in the dark about its gold holdings for several years. (Many still doubt that China has disclosed the full extent of its gold stockpile.) For reference, the People's Bank of China added about 14 tonnes of gold in October, more than 450,000 troy ounces of the yellow metal. This is the slowest pace of gold additions thus far this year.
China's gold reserves, as currently reported, stand as the world's fifth-largest (if the IMF's own holdings are excluded) with close to 1,700 tonnes reported.
While much of the reasoning for the IMF's move to add the yuan to the SDR has been attributed to the liberalization (opening up) of the Chinese economy, many experts have a different view—notably Currency Wars author James Rickards:
Implications of the SDR Change
What we mean by "liberalization" of China's economy is that the country has attempted to bring its currency value and the functioning of its markets in line with IMF guidelines. In the case of China, the adjustments have been slow. In addition to supposedly loosening its grip on propping up equities, the People's Bank of China has also made strides to bring the offshore (international) value of the yuan in line with its domestic value. (The former is allowed to float freely like other currencies, while domestically the price was kept under tighter controls.)
Rectifying this dislocation between the exchange rate and domestic value for the yuan has been the IMF's biggest challenge to the PBoC.
Changes to the SDR
When the IMF meets later today, it is expected to add the yuan to the SDR as part of its adjustment to the currency basket each five years. (The last time was in 2010.) Unavoidably, this will alter the way the currency basket is weighted. The SDR is currently composed of the following proportions:
41.9% U.S. dollar;
9.4% Japanese yen;
11.3% British pound sterling.
These weightings have changed gradually over time to reflect how widely each currency is used in international transactions, and how integral they are to the global financial system. Adding the yuan would be a bold statement about the global use of the currency, as well as elevating its international status. In response, the U.S. is even planning to set up yuan clearing and trading in the States. This is the first step in the greater financial cooperation that President Obama and Chinese President Xi spoke about when the Chinese leader visited the U.S. earlier this autumn.
Not everyone is convinced, however.
Not only is the yet unresolved issue with the offshore and domestic value of the yuan a big sticking point, but the yuan also falls short of the IMF's own criteria that the reserve currencies be "freely and widely used internationally" due to this dislocation. China still imposes capital controls, price floors and ceilings, and other similar restrictive policies.
Somewhat unsurprisingly, the Chinese are suspected of intervening in the markets to control the value of the yuan just hours before the IMF announces its decision.
In fact, by some measures, the renminbi appears less appropriate for SDR membership than the Australian dollar and Canadian dollar, neither of which is really even being considered for the currency basket.
The fact that the yuan is almost assuredly in line to be added to the SDR therefore speaks to China's increased political clout and its growing presence in the global economy.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.