What does this mean for the US-Dollar?
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The International Monetary Fund declared China’s Renminbi a main world currency on Monday. The announcement made by the Fund’s Managing Director Christine Lagarde means China’s currency will join the exclusive club of only four other currencies starting October 2016. The makeup of the currency basket had essentially remained unchanged for decades and previously only included the US Dollar, the Japanese Yen, the British Pound and the Euro (which replaced the German Deutschmark and the French Franc in 1999).
The move not only means a gain in reputation for China, which has now officially arrived in the big leagues of monetary policy, there are also very real positive effects regarding China’s standing as an economic power. Use of the renminbi in global trade and finance is likely to grow following the decision, even if some experts have called it premature.
Usually a currency has to be fully tradable to qualify for inclusion in the IMF’s currency basket which makes up the Funds Special Drawing Rights (SDRs).
SDR (or XDR) are a de-facto (if not de jure) currency, defined and maintained by the IMF, the value of with is based on the value of the currencies in the basket. Before the renminbi’s inclusion, the value of the US dollar accounted for 41.9% of one SDR. The rest was made up by the value of the Euro (37.4%), the Yen (9.4%), and the British Pound (11.3%). From October 2016 the renminbi will make up 10.92 % of the basket. Most of China’s new share is taken out of the Euro’s, which has lost considerable in credibility during its ongoing crisis.
While the Chinese leadership has been pursuing inclusion into the IMF’s basket for a long time, the move also presents Beijing with some potential difficulties.
First, there will have to be further reforms in order to make the move happen. In theory China’s currency will have to be fully tradable in order to be included. In reality it will have to closely approach that goal. Today, China is still heavily influencing the value of its currency to react to global as well as domestic developments. This has led critics, especially in the US, to accuse China of cheating to hold down the value of the renminbi in oder to improve its competitiveness in the global marketplace.
Secondly Bejing runs the risk of inviting a lot of foreign capital into the country within a rather short timespan.. Many central banks follow the IMF’s basket as a model for how to balance their own currency holdings. This means the extra demand for renminbi could spur a bubble in China when the central bankers and investors all pump money into the country at the same time.
While worries, that the renminbi might pose a challenge to the US dollar anytime soon are probably premature, the fact remains, that the rise of the Chinese currency introduces more diversity into the global banking system. Europe is another story. Here a relative decline vis a vis China has now become a harsh reality that political leaders are still reluctant to face.
At the same time the move gives investors more choice where they want to invest and through which institutions they which to do so. It also insulates the system against shocks by providing a fifth pillar for the global economy.