Why IMF giving the yuan reserve-currency status is a major victory for China

1 Dec 2015 | Author: | No comments yet »

IMF approves China’s yuan as elite reserve currency.

WASHINGTON (AFP) – The International Monetary Fund welcomed China’s yuan into its elite reserve currency basket on Monday (Nov 30), recognising the ascendance of the Asian power in the global economy.World leaders pledged to finish a deal to curb greenhouse gases and overcome a thorny divide on financing as they kicked off international climate talks in Paris against a backdrop of heavy security.The IMF just named the Chinese yuan to its basket of reserve currencies, a move hailed by many as a sign that the yuan is finally a major global currency, up there with the US dollar, euro, British pound and Japanese yen. No one expects the Chinese currency to seriously challenge the dollar for years to come; little will change in practical terms right away as a result of the IMF’s action.

IMF managing director Christine Lagarde called the decision “an important milestone in the integration of the Chinese economy into the global financial system.” “It is also a recognition of the progress that the Chinese authorities have made in the past years in reforming China’s monetary and financial systems.” The decision by the IMF executive board solidifies China’s ambition to see the government-controlled yuan achieve global status as one of the world’s top currencies alongside the United States, Europe and Japan. But by including the yuan in the currencies that make up its so-called Special Drawing Rights, now the dollar, euro, pound and yen, the IMF essentially endorsed the yuan as a currency that is stable enough and widely enough accepted to be a safe haven for assets.

The IMF’s able to perform that magic trick because it defines this as whether a currency is widely used for both global trade payments and currency-exchange trade. But, while already meeting the SDR criteria for being widely used, as recently as August the Fund considered the currency too tightly controlled to qualify. That’s powerful symbolism and represents a major victory for China, which five years ago lost an effort to be added to the IMF’s reserve-currency basket.

In fact, its recent rising popularity more likely reflects speculators’ one-way bet on the yuan’s appreciation against the dollar—an appeal that is now dimming fast. However, IMF staff experts in early November said that Beijing had taken the steps necessary for the yuan to be called “freely usable”, opening the way for Monday’s decision.

Despite Beijing’s tight control of its financial markets and recent criticisms of its bungled management of a stock market bubble, the IMF decision amounts to a big vote of confidence in China’s reform efforts and provides a boost in prestige for the current government under President Xi Jinping. Two years after Tesla CEO Elon Musk crowdsourced the idea for the Hyperloop, his dream of a ‘fifth mode’ of transportation is quickly and quietly becoming a reality. And it represents another large step for Beijing as its rise challenges the American-led financial system that has held sway since the end World War II.

If you look closer at the data, though, you’ll find that seven-tenths of those supposedly international yuan transactions are done in Hong Kong, says Ho-Fung Hung, professor at Johns Hopkins University and author of The China Boom: Why China Will Not Rule the World. Musk issued an open-source design challenge: a 28-passenger solar-powered pod capable of levitating through a system of tubes almost at the speed of sound, with a one-way ticket price of $20 and a total building cost estimated at $6 billion, less than a tenth of the budget for California’s high-speed rail project.

Though it has a separate legal and financial system, Hong Kong is also the primary financial channel through which mainland China interacts with the outside world. “Beijing policy is to designate HK as a ‘wholesale’ center of RMB trade,” says Hung, “with HK being a safe offshore financial market for China under tight political control of Beijing.” That makes most of Hong Kong’s yuan transactions an extension of China’s economy, he adds, reflecting “the RMB-ization” of the territory’s economy (RMB is another term for yuan). However, strip away Hong Kong’s influence, and the yuan claims only about 0.8% of international transactions—less than the Thai baht—notes Hung. Conventional wisdom says a large elderly population undermines an economy, and that Japan’s unprecedented aging condemns the country to a bleak future.

But just as likely it reflects… RMB speculation or hedging of that speculation.” One sign of speculation is sharp month-to-month variation in yuan use—for instance, though the yuan ranked fourth in SWIFT’s data in August, it fell to fifth place in September. As part of its “WSJ 2050: Demographic Destiny” series, The Wall Street Journal explores how entrepreneurs are exploring ways to unleash the potential of Japan’s elderly. If overseas demand for yuan was genuinely about the rising status of the currency as a unit of trade—and not about betting on how the yuan’s value will change—those offshore yuan deposits shouldn’t have shriveled so abruptly.

But in October the US Treasury Department softened its tone, saying that after Beijing’s moves to loosen controls, the yuan “remains below its appropriate medium-term valuation.” “With this decision, the IMF is choosing to reward China’s currency manipulation instead of combatting it,” said Senator Chuck Schumer, a New York Democrat and long-time China critic. “This decision is an affront to the millions of US workers who have lost their jobs at the hands of China’s rapacious trading practices, and sends a terrible signal to the rest of the world that currency manipulation is acceptable behavior in the eyes of the IMF.” Demand for yuan-denominated assets should also cheapen financing for Chinese companies—an attractive possibility for a country with nearly $17 trillion in corporate debt. Meanwhile, the IMF and the US government hope the yuan’s graduation to reserve currency status will encourage the Chinese government to continue to loosen its control over its financial system. For one, before the yuan becomes a true reserve currency, China must first stop effectively pegging to the dollar, says Derek Scissors, economist at the American Enterprise Institute.

The second step would be allowing the free flow of capital, particularly in and out of China’s bond market, which is currently mostly closed off to foreigner buyers.

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