The IMF votes today to decide whether to add the Chinese currency, called both the yuan and the renminbi, to its basket of four other currencies that make up its SDRs–special drawing rights. All signs are that the yuan will get the nod and jump into the basket alongside the US greenback, UK pound sterling, Japanese yen, and the euro.
Why do I consider this good news? Because it will make it tougher for the Chinese to manage their currency as they have in the past in order to gain a price advantage for their exports. But let’s at least scratch the surface of the background here.
SDRs are not in themselves a currency. You can’t buy a Snickers with them here or in any other country. Instead, they are international reserve assets that IMF member countries can themselves exchange in return for actual currencies. Countries can pay back IMF loans with SDRs or use them to rejigger their composition of currency holdings. Member countries with large trade surpluses, for example, can buy SDRs from those without such surpluses, thus balancing the currency holdings of the latter.
The bigger deal here for China is that SDR membership is a pretty rarified club. The currencies in the basket are all considered, to varying degrees, reserve currencies with an international stamp of approval in terms of their stability, reliability, and utility for trading in both goods and financial markets.
Since China has long been viewed by many as a currency manager/manipulator, the Chinese government views SDR designation as corroboration to their claim that they’re less interested in managing the yuan and more interested in pursuing financial and market reforms. They also probably like the idea of nudging King Dollar a bit off of his throne.
Why just a bit of a nudge? Since SDRs are weighted by export shares, won’t the yuan get a big weight, nudging the other currencies more than a bit? Probably not, because the IMF is considering switching from export-share weighting to financial-flow weighting, and the yuan plays a smaller role in financial markets than in international product markets.
How can I be so blase about the challenge to the dollar’s premiere reserve status? You know my methods, Watson–I and others have written that what was once a privilege is now a burden, leading to persistent trade deficits as export-oriented economies seeking to boost reserves collect dollars, raising their relative price and making our exports less competitive.
I don’t think the yuan or any other currency will give King $ much of a bump in the near term, and we still have to be vigilant about currency management and other methods that generate external imbalances among all of our global partners. As no less than Ben Bernanke has recently written, Germany’s trade surplus of 7% of GDP–that’s big, btw–is sapping demand from lots of other countries in Europe who really don’t need that problem right now.
Also, China still holds over $3 trillion in reserves, and that’s mostly dollars. Clearly, even if flows are neutral, such a large stock of holdings puts some upward pressure on the value of the dollar, much like the Fed’s holdings of trillions in government and agency debt put downward pressure on interest rates. And what about China’s capital controls (the government’s pretty tight control of external flows of the yuan)? That seems inconsistent with SDR status.
All that said, as a reserve currency in the SDR mix, China will surely be less likely to aggressively manage their currency such that it is significantly misaligned in terms of its value against other currencies. And for those of us who worry about US trade deficits that have been significant negatives for about 40 years (!) and thus a barrier to achieving full employment, that’s good news.
Update: It’s official. They’re in.