The IMF just approved the Chinese yuan as a major world currency. What comes next is political
“And the sixth angel poured out his vial upon the great river Euphrates; and the water thereof was dried up, that the way of the kings of the east might be prepared.” Revelation 16:12 (KJV)
EDITOR’S NOTE: The Bible says that in the end times, China is a major world player, and that is exactly the direction we now see them moving in. They are currently the world’s second largest economy behind the United States, and advancing quite rapidly. They would love to see the dollar booted and the Yuan take it’s place. Will it happen? It just might…let’s see how the markets react to today’s stunning news.
On Monday afternoon, the International Monetary Fund’s (IMF) Executive Board voted in favor of allowing China’s currency — the yuan (or renminbi) — to join the ranks of the world’s most elite monies. On Oct. 1, 2016, the yuan will officially be added to the IMF’s Special Drawing Rights (SDR) basket of currencies, which previously included only the dollar, euro, yen, and pound sterling. The decision to include the yuan in the basket indicates the board felt the yuan meets the required “freely useable” standard, meaning it is widely used to settle international transactions and widely traded in foreign exchange markets.
The move legitimizes the yuan as a global reserve currency — an important designation that I will explain below. And which governments will start investing most significantly in yuan? Those that dislike the U.S.-led international order, as I will explain.
What is a reserve currency?
Just like individuals, governments maintain their own investment portfolios that function as a sort-of “rainy day fund.” Typically, central banks operate as their country’s investment managers, regularly making decisions about how best to allocate the government’s financial assets.
A key part of this process is deciding on the currency denomination of their investments. For example, if a central bank decides to invest heavily in Treasury bonds, that means the country holds a lot of U.S. dollars in reserve. Investments in German government bonds, conversely, represent euro holdings. These assets are appropriately referred to as “foreign exchange reserves.”
Central banks typically hold a blend of currencies in their foreign exchange reserves. Today, the U.S. dollar is the world’s most popular reserve currency, representing roughly 64 percent of global reserve assets. The second most popular is the euro, at about 20 percent, and the pound sterling and yen come in at about 5 and 4 percent respectively.
That means roughly 93 percent of the world’s foreign exchange reserves are held in one of these four currencies. Typically, when people use the term “reserve currency” they are referring to this exclusive group.
These are the four currencies listed in the IMF’s SDR basket. In practical terms, the SDR’s primary function is as a unit of account for the IMF, with official IMF documents reporting the institution’s own assets and liabilities in SDR terms. Its value, which changes daily, is based on the exchange rates of the four — soon to be five — currencies in the SDR basket.
Why does the IMF’s decision matter?
The IMF’s opinion means something to reserve currency managers and financial markets. Including the yuan in the SDR basket can be thought of as the IMF’s Good Housekeeping “Seal of Approval,” signalling that it is ready for the big time as a global investment and trade settlement currency.
Recently, one major global bank predicted that SDR classification could lead asset managers, including central banks and private investors alike, to shift a whopping $1 trillion into yuan. Issuing a top reserve currency tends to be quite beneficial. For example, the dollar’s role as a top reserve currency is one of the reasons the U.S. government is able to borrow from foreign creditors so cheaply. These low rates are transferred on to American citizens. Estimates suggest that top reserve status confers an estimated $100 billion on the U.S. economy, annually.
If global demand for the yuan grows, Beijing would benefit in similar ways.
Of course, SDR classification alone will not propel the yuan to challenge the dollar for the position of top global reserve currency. Reserve decisions are largely driven by the economic attractiveness of particular currencies.
Governments that issue top reserve currencies need to provide large and open financial markets where foreign investors — including central banks — can buy and sell assets in the currency freely and quickly. China is slowly moving in this direction.
A relatively stable exchange rate also enhances a reserve currency’s economic attractiveness. Similarly, the more the yuan is used in trade settlement and debt markets, the more likely central banks are to increase their holdings of the currency.