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At present, the Chinese Yuan is not one of the key international
currencies. It is not incorporated in the IMF's basket of key
international currencies, but there is much discussion in the
international economic community regarding this possibility. If the Yuan were to become a key international currency, banks and other financial intermediaries and institutions would likely increase their
reserves and portfolio holding percentages of the Yuan, driving its
exchange value upward. Some additional effects associated with this
legitimization and full acceptance of the Yuan would be a reduction in
the international exchange value of the U.S. dollar (versus many
currencies), a substantial increase in the cost of goods manufactured in
China (these goods are currently very competitively-priced in the
global marketplace, and give China a tremendous advantage over other
countries in terms of the economic viability of exports) which would have the effect of severely
disrupting the Chinese balance of trade and balance of payments. The effect of this swing could have catastrophic effects on the entire global economy. More about the IMF and the SDR follows:
The SDR ("Special Drawing Right") is an international reserve asset, created by the IMF ("International Monetary Fund")
in 1969 to supplement its member countries’ official reserves. Its value
is currently based upon a "basket" of four key international currencies, and SDRs can
be exchanged for freely usable currencies. With a general SDR
allocation that took effect on August 28, 2009 and a special allocation
on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion
to approximately SDR 204 billion (equivalent to about $309 billion, converted
using the rate of September 4, 2014).
The role of the SDR
The SDR was created by the IMF in 1969 to support the Bretton Woods
fixed exchange rate system. A country participating in this system
needed official reserves—government or central bank holdings of gold
and widely accepted foreign currencies—that could be used to purchase
the domestic currency in foreign exchange markets, as required to
maintain its exchange rate. But the international supply of two key
reserve assets—gold
and the U.S. dollar—proved inadequate for supporting the expansion of
world trade and financial development that was taking place. Therefore,
the international community decided to create a new international
reserve asset under the auspices of the IMF.
However, only a few years later, the Bretton Woods system collapsed
and the major currencies shifted to a floating exchange rate regime. In
addition, the growth in international capital markets facilitated
borrowing by creditworthy governments. Both of these developments
lessened the need for SDRs. But more recently, the 2009 SDR allocations
totaling SDR 182.6 billion have played a critical role in providing
liquidity to the global economic system and supplementing member
countries’ official reserves amid the global financial crisis.
The SDR is neither a currency, nor a claim on the IMF. Rather, it
is a potential claim on the freely usable currencies of IMF members.
Holders of SDRs can obtain these currencies in exchange for their SDRs
in two ways: first, through the arrangement of voluntary exchanges
between members; and second, by the IMF designating members with strong
external positions to purchase SDRs from members with weak external
positions. In addition to its role as a supplementary reserve asset, the
SDR serves as the unit of account of the IMF and some other
international organizations.
Basket of currencies determines the value of the SDR
The value of the SDR was initially defined as equivalent to 0.888671
grams of fine gold—which, at the time, was also equivalent to one U.S.
dollar. After the collapse of the Bretton Woods system in 1973, however,
the SDR was redefined as a basket of currencies. Today the SDR basket
consists of the euro, Japanese yen, pound sterling, and U.S. dollar. The
value of the SDR in terms of the U.S. dollar is determined daily and
posted on the IMF’s website. It is calculated as the sum of specific
amounts of the four basket currencies valued in U.S. dollars, on the
basis of exchange rates quoted at noon each day in the London market.
The basket composition is reviewed every five years by the Executive
Board, or earlier if the IMF finds changed circumstances warrant an
earlier review, to ensure that it reflects the relative importance of
currencies in the world’s trading and financial systems. In the most
recent review (in November 2010), the weights of the currencies in the
SDR basket were revised based on the value of the exports of goods and
services and the amount of reserves denominated in the respective
currencies that were held by other members of the IMF. These changes
became effective on January 1, 2011.
In October 2011, the IMF Executive
Board discussed
possible options for broadening the SDR currency basket. Most directors
held the view that the current criteria for SDR basket selection
remained appropriate. The next review will take place by 2015.
The SDR interest rate
The
SDR interest rate provides the basis for calculating the interest charged to members on regular (non-concessional) IMF loans,
the interest paid to members on their SDR holdings and charged on
their SDR allocation, and the interest paid to members on a portion of
their quota subscriptions. The SDR interest rate is determined weekly
and is based on a weighted average of representative interest rates on
short-term debt instruments in the money markets of the SDR basket
currencies.
SDR allocations to IMF members
Under its Articles of Agreement (Article XV, Section 1, and Article
XVIII), the IMF may allocate SDRs to member countries in proportion to
their IMF quotas. Such an allocation provides each member with a
costless, unconditional international reserve asset. The SDR mechanism
is self-financing and levies charges on allocations which are then used
to pay interest on SDR holdings. If a member does not use any of its
allocated SDR holdings, the charges are equal to the interest received.
However, if a member's SDR holdings rise above its allocation, it
effectively earns interest on the excess. Conversely, if it holds fewer
SDRs than allocated, it pays interest on the shortfall. The Articles of
Agreement also allow for cancellations of SDRs, but this provision has
never been used. The IMF cannot allocate SDRs to itself or to other
prescribed holders.
General allocations of SDRs have to be based on a
long-term global need to supplement existing reserve assets. Decisions
on general allocations are made for successive basic periods of up to
five years, although general SDR allocations have been made only three
times. The first allocation was for a total amount of SDR 9.3 billion,
distributed in 1970-72, and the second allocated SDR 12.1 billion,
distributed in 1979-81. These two allocations resulted in cumulative SDR
allocations of SDR 21.4 billion. To help mitigate the effects of the
financial crisis, a third general SDR allocation of SDR 161.2 billion
was made on August 28, 2009.
Separately, the Fourth Amendment to the Articles of Agreement became effective August 10, 2009 and provided for a
special one-time allocation of SDR 21.5 billion.
The purpose of the Fourth Amendment was to enable all members of the
IMF to participate in the SDR system on an equitable basis and rectify
the fact that countries that joined the IMF after 1981—more than one
fifth of the current IMF membership—never received an SDR allocation
until 2009. The 2009 general and special SDR allocations together raised
total cumulative SDR allocations to SDR 204 billion.
Buying and selling SDRs
IMF members often need to buy SDRs to discharge obligations to the
IMF, or they may wish to sell SDRs in order to adjust the composition of
their reserves. The IMF may act as an intermediary between members and
prescribed holders to ensure that SDRs can be exchanged for freely
usable currencies. For more than two decades, the SDR market has
functioned through voluntary trading arrangements. Under these
arrangements a number of members and one prescribed holder have
volunteered to buy or sell SDRs within limits defined by their
respective arrangements.
Following the 2009 SDR allocations, the number
and size of the voluntary arrangements has been expanded to ensure
continued liquidity of the voluntary SDR market. The number of voluntary
SDR trading arrangements now stands at 32, including 19 new
arrangements since the 2009 SDR allocations.
In the event that there is insufficient capacity under the voluntary
trading arrangements, the IMF can activate the designation mechanism.
Under this mechanism, members with sufficiently strong external
positions are designated by the IMF to buy SDRs with freely usable
currencies up to certain amounts from members with weak external
positions. This arrangement serves as a backstop to guarantee the
liquidity and the reserve asset character of the SDR.
---------------
At present, the IMF is a political and economic powerhouse, operating behind the scenes to "regulate" and stabilize the global economy. The IMF has become infamous for attaching political obligations to its issuance of funds to developing nations and countries in economic crisis. It is, unquestionably, a powerhouse, and in the event that it elects to include the Chinese Yuan in its "basket" of key international currencies, the entire world might suffer another economic meltdown (recalling 2008-2009) as a result. The only beneficiaries in this scenario would be those investors and money managers who 1) bought and held the Yuan in their portfolios and 2) sold off their holdings during the period of the Yuan's "initiation" into the basket of key international currencies.
As always, thank you for reading me.
Douglas E. Castle For
The Internationalist Page Blog
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