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Mar 1, 2016

The Yuan Now Part of IMFs SDR: Who Cares?

by Marie-Josée Loiselle

Marie Josee LoiselleOn Monday November 30, 2015, the International Monetary Fund (IMF) agreed to add the Chinese yuan to its reserve currency basket. Lately, the United States and the IMF had supported its inclusion in the basket, known as Special Drawing Rights (SDR). The yuan will join the euro, yen, pound and dollar in the reserves basket. The yuan will have about an 11 percent weighting in the SDR. The assumption is that this will increase the demand for the yuan. This is funny because the SDR is not a freely traded currency (it is actually not a currency—more below) nor is the yuan. Beijing is tightly controlling the exchangeability on international markets.

This was touted as major news in the financial media. Christine Lagarde, the IMF managing director, indicated that “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". This assumes that the IMF is important in the world economy. It is not—except for indebted countries like Greece and for PhDs in economics.

If you have never heard of the SDR, you’re not missing much. In hard money circles, people like to talk about the SDR believing apparently the SDR may take over the US dollar or may become the “world reserve currency” because some countries would back the SDR with gold. We will see below how this is nonsense.

But first, what are special drawing rights (SDR) and why were they put in place? The SDR represents a basket of the most traded currencies: US dollar, British pound, the euro and Japanese yen. The SDR were part of the discussions of Bretton Woods in 1944: it was an era of fixed exchange rates. The IMF would lend so-called SDR to stabilize bank runs in a context of fixed exchange rates. That ended in 1971 when Nixon closed the gold window. We have been on floating exchange rates since. In floating exchange rates, there are no bank runs. They could have closed the IMF then. But “government agencies” and “close” don’t go in the same sentence. It never happens.

Why is this not important in a monetary sense? Because as mentioned above, SDR are not “currency”. They are fake accounts entries for über-indebted countries like Greece and Third World nations. You can also call it a Washington, DC political tool: this morning, the IMF announced that it is forgiving Ukraine’s debt to Russia (Ukraine owes Russia $3B). Along with a new policy: only loans in US dollars owed to US allies will be enforced. Well, well, it didn’t take long before the yuan didn’t matter much, did it?

Before going back to the crazy idea of SDR taking over in terms of world reserve currency or the thought that there is some plan to link them to gold, first, let’s understand what money is. Money is the most marketable commodity. The fundamental aspect is that it is accepted in trade. It is liquid, no commissions. By this definition, SDR are not money. You can’t buy anything with SDR. Nobody trades in SDR.

You could say the same thing of the Chinese yuan: it is not widely used in world trade. The latest figures show 2% of world trade uses the yuan, and that is mainly in Asian trade. At the top of the throne is still the US dollar followed by the euro, UK pound, and Japanese yen.

Why is the US dollar still on top? It is really nothing inherent to the US dollar per se but because the American consumer likes to buy stuff and lots of it. Plus, US tariffs are relatively low on imported goods. Thus, many foreign countries hold dollars because they all adopted mercantilist policies: they all want to sell to the US, and to do that they push for a cheap currency. To have a cheap currency, they have to create theirs out of thin air (more supply, cheaper price) and buy US Treasuries to bid the price of the US dollar upward (more demand, price up). Put another way, they subsidize their exporters by inflating their currency and they hurt their local population with a cheap currency (imports). They end up subsidizing the American consumer.

In this context, do you seriously think that the apparatchiks of the PBOC (People’s Bank of China), who are Keynesians and mercantilists to the core, will decide to have their hands tied to gold (meaning they can’t manipulate the yuan)? They will have their friends’ exporters cry bloody murder in a New York minute. Hard money circles are always speculating (because it is speculation when it comes to China’s figures) that the PBOC has bought X tons of gold and here we go, China is marching toward the gold standard! Chinese citizens surely buy gold because they don’t trust the PBOC and they’re right, but this has nothing to do with China becoming a beacon of free market money. They can talk about the evil US dollar all they want but they are the enablers. Nobody is asking them to devaluate their currencies to prop up the US dollar. It has been proven for a very long time that mercantilism doesn’t work, that it is a race to the bottom, but logic is not part of politicians’ mindset.

But fear not, apparently, if China can’t dethrone the US dollar alone, it will lead the way with the IMF to create a new SDR with the BRIC’s currencies (BRIC: Brazil, Russia, India, China)—and backed by gold, thank you very much. Ah yes, a basket of currencies from a communist country, a former communist country and Third World nations—what’s not to like?

So bottom line, the IMF doesn’t have a currency of its own, doesn’t have a central bank, is not a nation, has no taxing power and no producing power. No money. It is a public relation tool for some Western governments and a “command and control” wet dream for academics. It needs to borrow money from other governments. If you follow politics, you can be entertained with the IMF. If you care about understanding economics and money, you can safely ignore it.

Marie-Josée Loiselle, BEcon, MPA, President,

MJ Economics,Montreal, QC (514) 574-6641 (her blog!)