The International Monetary Fund (IMF) has recently announced that they will accept the Chinese Yuan into the IMF’s Special Drawing Rights (SDR). Questions arise as to whether this will lead to its appreciation as a reserve currency. The final decision will be made during November, and if it is accepted, the Yuan will function as part of the SDR starting October next year.

What is the SDR?

The SDR is a foreign currency reserve, where major world currencies are thrown in to be used like an alternate currency. It is assigned to each IMF member nation, and the basket is partitioned according to the amount of each country’s investment. Currently the SDR consists of the U.S. dollar, the euro, the pound sterling, and the Japanese yen.

Although it can be used like a currency, it is not a currency per se, as it is not used in the market or for monetary dealings. It is used as a contingency fund for each country’s government. For instance, if the yen were about to collapse, the Japanese government can use their funds in the SDR, convert it to a foreign currency and buy back the yen to support it. In recent times, Greece used this method to repay their loans to the IMF. So it is a contingency fund that each government can use in foreign currency dealings with other countries.

What will happen if the Yuan joins the SDR?

The most significant things would be that the Yuan would gain more trust. If the Yuan is accepted as an SDR currency, other countries can add the Yuan to their reserve funds with confidence. Even amongst ordinary people, the Yuan could gain confidence, and Yuan trade will become more active.

The AIIB, which hit the headlines a while back will likely be dollar-dominated at first, but entry into the SDR will shift it to Yuan-dominated activities. If this is the case, debts in the AIIB will have to be repaid in Yuan, so the Yuan trade will increase rapidly.

In addition, if the Chinese Yuan were to join the SDR, their voice inside the IMF will enhanced, which will give them greater influence in the world economy.

The Yuan Has Failed To Meet The SDR Conditions

This is very advantageous to Chine in their attempts to strengthen their influence around the world. On the contrary, however, this is bad news for other countries including Japan. This is because the Yuan is different compared to other SDR currencies in that it is under a managed float regime (also known as a dirty float) where the Bank of China can essentially controls its exchange rate. It has not switched to the genuine floating exchange rate system idealized by the IMF. Thus the Yuan has failed to meet the SDR condition that the currency be freely usable.

It is preposterous that the IMF should accept such a currency. In addition there is danger lurking just around the corner. If the Yuan does end up switching to the floating exchange rate system, some analysts predict that it will collapse, throwing the world economy into chaos.

The Yuan, yet to be fully trusted as a currency, should not be added to the SDR.

A Currency War Between The U.S. and China?

Reports have aptly labeled this state of affairs as a ‘currency war between the U.S. and China’. Since most international trading is done with the U.S. dollar, it means that the U.S. can buy anything as long as they keep printing U.S. dollars. Not only that, but if they decide to suspend trade with a particular country, they have the power to impose economic sanctions. As such, the U.S. dollar is incredibly powerful.
China wants this economic power by taking America’s place. China’s desire for economic dominance is gradually becoming apparent. Some countries have been looking to aid China’s economics due to the potential of its market, but China’s government has an appalling human rights record, with frequent reports of torture and extrajudicial murder. Those countries must realize that as they provide support to China, they could eventually fall under China’s influence.
It is much like human relationships: no one would befriend a wealthy man if he were a violent wretch. China’s human rights record as well as its aggressive expansion in its near seas must be reckoned with before sound economic relations can be founded.