In a widely anticipated event, the International Monetary Fund (IMF) is expected to soon bless China’s currency, the yuan, with official reserve currency status.
This month, the IMF is likely to include the yuan in the select group of global currencies included in its Special Drawing Right (SDR) basket, joining the dollar, euro, yen and the pound.
And for months now there have been wild stories floating around the financial world that the IMF’s move will result in massive — and potentially destabilizing — shifts in foreign-exchange markets.
One of the more sensational versions of this story strongly implies the dollar’s reserve currency status will be threatened, perhaps triggering a collapse in the value of the buck, and a global currency crisis.
Nothing could be further from the truth.
|Will the yuan threaten the mighty dollar?|
The IMF’s pending move should actually help over time stabilize the global financial system, which is far too dollar-dependent today. But this doesn’t mean the yuan will suddenly rival the dollar for global reserve currency dominance.
Is the yuan even ready for prime time?
That the yuan is even being considered as a reserve currency by the IMF is still a surprise to many investors. In spite of recent reforms, China’s financial system remains tightly controlled, and the yuan is still not freely convertible.
Although the global acceptance of the yuan has increased dramatically in recent years, it’s nowhere near as widely used as most other major currencies.
In 2012, the yuan was the world’s 20th-most used currency for cross-border payments, but has surged to fifth place now.
Yet, the yuan only accounts for about 2.5% of total global payments by value today.
Still, there’s no denying that China’s rapid economic rise suggests the yuan is quickly gaining reserve currency status. After all, China is the world’s second-largest economy and has been the world’s leading exporter since 2009.
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China has taken important steps toward financial reform, including opening its mainland financial markets more to international investment and expanding its fixed-income markets.
The IMF staff has said the yuan now meets the qualifications for inclusion in the SDR basket, and the U.S. is apparently ready to support the move.
But make no mistake — this is still largely a symbolic move for China’s currency.
SDR inclusion is a symbolic, not substantial, move for the yuan
The SDR basket is set up as a kind of overdraft account for IMF member countries, convertible into dollars, euros, pounds and yen. But we’re not talking about a great deal of money here.
According to Bloomberg, the outstanding value of SDRs is just over $300 billion, which is only 2.5% of global currency reserves.
And the yuan is not very widely used compared with the other four SDR currencies. At the end of last year, it ranked eighth in international bond issuance and 11th in global currency trading.
At least initially the yuan will account for only a small fraction of the SDR basket anyway, which is now dominated by the U.S. dollar with roughly a 40% weight with the euro accounting for a slightly smaller share.
Over 80% of total foreign-exchange trading involves the dollar today, so adding the yuan to the SDR mix isn’t likely to create much competition for the buck in terms of global currency dominance.
If anything, it’s the stature of the euro that is likely to be diminished. After all, its role as a global reserve currency has already been tarnished by the ongoing European sovereign debt crisis.
And as far as triggering massive shifts in global currency markets, don’t expect a tsunami of money to move into the yuan overnight.
In fact, JP Morgan estimates the IMF’s blessing could result in about $350 billion moving into Chinese bonds over the next five years, a subtle reallocation of reserves. And that’s just a drop in the bucket compared with the $1.3 trillion worth of U.S. Treasurys held by China today, not to mention the $12 trillion in total currency reserves held worldwide.
Bottom line: Don’t believe the hype about a coming collapse of the U.S. dollar as China’s yuan soon becomes the global reserve currency of choice. That’s NOT about to happen.
It will take years for the yuan to become a true international currency, as widely used as the dollar is today for funding and investing. There’s no doubt in my mind that day will come eventually, but not anytime soon.
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