She said: ‘IMF staff assesses that the RMB meets the requirements to be a “freely usable” currency and, accordingly, the staff proposes that the Executive Board … include it in the SDR basket’. The US and Japan, which had previously been cautious about including the RMB, seem to have softened their stance, so it is likely that the Board will decide in favour of the proposal.
The SDR has several different roles in the operation of the IMF, but the issue to be discussed is its role as the unit of account. The value of the SDR is currently linked to a basket of four global currencies: the US dollar, the euro, the British pound and the Japanese yen, with their weights being 42, 37, 11 and 9 per cent, respectively. The currencies in the basket and their weights are chosen to reflect global trade and financial trends, so that it can be an effective yardstick for the IMF’s general operations.
The idea of including RMB as a fifth currency in the basket has been floating for some time, including when the previous review of the SDR was conducted in 2010. Back then, China was already well-qualified under one of the two criteria for SDR inclusion: it was a major global exporter of goods and services. But the Executive Board considered that the RMB did not meet the other criterion of being a ‘freely usable’ currency. This time, the IMF staff has assessed the RMB’s ‘free usability’ differently, and the door to the SDR has been opened.
Will this be a blessing for China, and if so, in what sense?
It should be noted that inclusion in the SDR is very different from increasing China’s share in the IMF quota, which has also long been pending. The IMF’s quota represents the member country’s voice in the decision making at the IMF, and is closely linked to the country’s influence over the IMF.
In contrast, inclusion in the SDR offers no privilege to the currency issuer country. China gains no tangible benefits inside the IMF from the RMB being included. Outside the IMF, some have argued that including the RMB in the SDR will shift global investors’ asset portfolios toward the RMB, including those held by sovereigns as foreign reserves. This could happen, but there is no logical reason why it should. After all, the SDR is just a matter of how the IMF does its internal accounting. One should not make too much out of it.
Yet it is clearly a symbolic victory in China’s efforts to raise its status in the international financial community, commensurate with its growing importance in the global economy. If the RMB is included in the SDR, it is still not clear what its weight will be at this point. But an August IMF staff paper estimated it to be ‘14–16 per cent’ based on the existing formula. This means the RMB would jump over both the pound and the yen. This will send a clear signal to the world that the RMB is a very important international currency.
China has argued since the global financial crisis that the US dollar-dominated international financial system excessively exposes investors to US risks. In his speech in March 2009, the Governor of the People’s Bank of China Zhou Xiaochuan noted that there is a need to create a super-sovereign currency whose value does not depend on any particular country’s economic fortune. He stressed that the SDR can play this role. Although the use of the SDR outside the IMF is unlikely to expand anytime soon, it is logical that China wants the RMB to be part of what it believes should be the vehicle currency of the future.
So once the SDR issue is settled, what will be China’s next move?
An obvious candidate is liberalising its capital account, which will no doubt further internationalise the RMB. But in October, Chinese authorities removed the cap on deposit interest rates, which was a major step toward domestic financial deregulation. While this was long expected and awaited, it is potentially very risky. If history is a guide, deregulating the deposit rate often drives banks into competition, creates financial excesses, and eventually leads to market instability.
It is therefore advisable for Chinese authorities to move cautiously. Their next major action toward deregulation can wait until they are assured that the domestic financial sector has fully adjusted to interest rates determined by the market. Perhaps more importantly, regulatory authorities will want enough confidence in their ability to detect the sources of financial instability, and to nip them in the bud.
Masahiko Takeda is a professor in the School of International and Public Policy, Hitotsubashi University.
A very thoughtful article. Thank you.
At Bretton Woods in July 1944, the US dollar replaced the pound sterling as the world reserve currency (WRC), backed by gold at US$35 per oz of gold.
Previously, the Western WRCs were first,the Portuguese escudo, followed by the Spanish peso, then by the Dutch gilder, then by the French franc and the pound sterling, following the Rise and Fall of Western Empires.
The US dollar, also known as the Federal Reserve Notes, served well as the WRC until the US decided to print more paper dollars than there were gold to back them up, to paper the huge cost of the 10-year war in Vietnam.
France and many countries saw through the scam and started to cash their huge dollar cache (she accrued from US tourist) and redeemed for gold at only US$35 an oz.
Today, that same oz of gold France redeemed is worth US$1,080, showing that the US dollar has depreciated by nearly 3,000% since 15 August 1971, when President Nixon had no choice but to close the gold window “temporarily”.
That resulted in a floating regime in 1973 and since then the US dollar is backed by nothing and its huge national debts is now US$18.5 trillion.By the time Obama leaves in Jan 2017, it will soar to US$20 trillion.
The SDR today is also backed by nothing and its value is “currently linked to a basket of four global currencies: the US dollar, the euro, the British pound and the Japanese yen, with their weights being 42, 37, 11 and 9 per cent, respectively.”
Why should the SDR’s value be linked by 42% in weighting to the US dollar, which has depreciated by 3,000% against gold since 15 August 1971 and the US is the biggest debtor in the world?
“China has argued since the global financial crisis that the US dollar-dominated international financial system excessively exposes investors to US risks.”
This is correct.
“In his speech in March 2009, the Governor of the People’s Bank of China Zhou Xiaochuan noted that there is a need to create a super-sovereign currency whose value does not depend on any particular country’s economic fortune.”
This also is the most credible suggestion.
So why shouldn’t the SDR be backed by gold (real money) at the rate of say US$5,000 or MORE to create a sustainable amount of ‘real’ money for world trade?
For the SDR to be backed by nothing is only to perpetuate a scam, a ‘free lunch’ enjoyed by the US for the last 44 years.
China today has about 1.650 tons of central bank gold and an unknown amount of silver.
In the last 30 years China may have produced at least 300 tons of gold a year (not sold outside of China), which equate to another 9,000 tons. The grand total is approx 10,065 tons vs about 8100 tons in the USA (if any).
If China buys more gold with her US$3.8 trillion of foreign reserves then China will have, by far, the most amount of gold in the world, enough to back the RMB.
If the RMB is backed by gold, then the RMB will be the new world reserve currency, replacing the SDR itself, which is backed by nothing but an IMF weighting scam.
Kittan,
I agree with most of what you have written except for the very end. If you or anyone understands Zhou Xiaochuan’s words, it is quite obvious China does not want to be the next replacement in line for the Yuan to become the world’s sole reserve currency. The Chinese are smart enough to know that if that ever happened it will be only a matter of time before they end up like the US in the present. Heavily indebted with a future of ruin.
The Chinese and most of the world’s people know quite well that a basket of currencies where all countries get equal benefit and risk would be the most stable for the long term. Every currency should be part of the SDR. The weaker the national economy, the less of a share that currency will have in the SDR.
I can see China once in the SDR working with the EU and England to force the IMF to open its doors to more currencies and rebalancing the SDR that favours all nations. Of course, it will have a negative effect on the US dollar, where the dollar will weaken and the US economy and control over world affairs will weaken as well.
But in the long term it will result in a stronger economy for the whole world.
@ Daniel
Thank you for agreeing with most of what I wrote.
What Zhou Xiaochuan noted is that “there is a need to create a super-sovereign currency whose value does not depend on any particular country’s economic fortune.”
True, he did not day that China wants to create such a super-sovereign currency and he also did not define what is a super-sovereign currency.
But can a piece of IMF paper with the alphabets “SDR” printed on it be called somehow a super-sovereign currency, when it has no intrinsic value and can be printed in unlimited amounts by the US/French-controlled IMF?
To suggest that “Every currency should be part of the SDR” will only go to compound the IMF’s SDR weighting mess it is now in.
The SDR will still be not a super-sovereign currency as it backed by nothing but more fiat paper money, which the CB of each country can print in unlimited amounts or create out of thin air by the commercial banks.
IMHO, the super-sovereign currency has to keep its purchasing value for a long time (unlike the US dollar which has depreciated against gold by 3000% since 1971) and must be backed by precious metals like gold and silver, which the IMF or any central bank cannot create out of thin air and then all the world’s currencies are pegged to them, based on an agreed formula.
There are about an estimated 170,000 tons of above-ground gold and about 1.411 million tons of above-ground silver, according to estimates by experts, which should be enough to back the super-sovereign currency.
Please note that until 15 August 1971, when President Nixon closed the gold windows and reneged on the Btetton Woods agreement, there was no time in world history that paper money was not backed by either gold or silver.
Thank you very much for your comment. Let me respond by making two points that go against your proposal.
First, fiat money (not backed by gold or some such tangible assets) may seem like a scam, but it has been proven to be a lot more flexible and useful than commodity money in the sense that monetary authorities can adjust supply of money at will to smooth out economic fluctuations.
Second, the flip side of the benefit stated above is the risk that this flexibility is abused, leading to persistent and high inflation. However, we haven’t seen this risk materialize for decades. If anything, the risk of deflation is prevalent in many advanced countries. This suggests that central banks have learned how to use fiat money well.
If fiat money is more flexible and at the same time its possible side effect is absent, why should we go back to the straightjacket of the gold standard?
Masahiko, I guess you missed the part about the bankers/wallst/Wash/Feds lying, stealing, cheating, and manipulating the system because they can print at will. A currency backed by gold is the only answer, otherwise the greedy little scam artists will print us to death. Look how well we’ve done with the current situation, $200 trillion in debt.
Hi, Donald, you are quite right. The reason why the US was able to indulge in their excesses before the global financial crisis was because international investors trusted the bankers/wallst/Wash/Fed/etc. If it had not taken place in the US, the subprime party couldn’t have lasted so long, and the problem wouldn’t have become so deep and serious. And the US authorities have indeed supplied a huge amount of dollar liquidity since the crisis.
That the US was able to do this was because the dollar had a very special status in the world. If this was some other country (e.g., Brazil or Russia), its currency would go to pieces even if the central bank raised interest rates sky high (instead of pushing them down to zero as the Fed did).
But this is the point. The dollar DID NOT go to pieces during and after the crisis. This in spite of all the talk by renowned economists in the 2000s about the “global imbalance” and the unsustainability of the dollar’s exchange rate ! What does this tell us?
The dollar is not backed by any commodity, and as such, looks like a scam. The US has been “printing money”, as you put it, like crazy. Yet, no one has lost his/her money from the dollar’s sharp depreciation. No hyper inflation has taken place in the US, and not a moderate one is in sight right now. It appears that commodity backing is not a crucial factor when it comes to the determination of money’s value. If this is the case, why should we call it a scam?
Thank you, Masahiko, for joining in the debate.
1 You said ” First, fiat money (not backed by gold or some such tangible assets) may seem like a scam, ”
Fiat money is a scam and has been in the US since the Federal Reserve Act was signed into law by Pres. Wilson in 1913, even though the US Constitution states that only Congress can coin money. Google “Why the corrupt Federal Reserve is not federal” by the Biblicism Institute.
Jefferson once said “If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations, that will grow up around them, will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered.”
The Fed prints the Federal Reserve Notes (a note is a debt) and exchanges them with the US Treasury for bonds (Usury), when the US Mint can print US dollars for free.
The US National Debt is US$18.5 trillion today, rising at the rate of US$ 1 trillion a year in just the last 7 years. And the unfunded debt is US$222 trillion. Hard to believe?
Go to RT dot com and add these to the website link: usa/debt-crisis-us-kotlikoff-535/
2 “but it has been proven to be a lot more flexible and useful than commodity money in the sense that monetary authorities can adjust supply of money at will to smooth out economic fluctuations.”
If that is true then we will not have the colossal global US$200 trillion debt mess today, according to the McKinsey Global Institute report, released in Feb.
According to Forbes, in 2008 the Fed single-handedly allocated “over $16 trillion to corporations and banks internationally, purportedly for ‘financial assistance.’ ”
Other sources put it at close to $30 trillion. And none of that money has been accounted for. These transactions were only discovered after a “quick audit” was miraculously squeezed out of the Fed by the then Congressman Ron Paul
So who really got all that money? Was it only $16 or 30 Trillion? No one knows. Not even Congress. And no US politician would even dare utter a word about it, maybe except Ron Paul and Donald Trump.
3 “Second, the flip side of the benefit stated above is the risk that this flexibility is abused, leading to persistent and high inflation. However, we haven’t seen this risk materialize for decades.”
The devil is in the details on how one defines ‘Inflation’. The current definition is bogus and is divided into ‘Core Inflation’ and ‘Headline Inflation’. But these are only ‘Price Inflation’,a symptom of Inflation which is correctly defined as simply an increase in the total stock of money.
In 2007 the Fed’s balance sheet was about US$800 billion. Today, it has crossed the Rubicon to over US$4 trillion, after 3 QEs (at US$85 billion a month). If that was not inflationary then what is?
And the Fed managed to cap ‘price inflation’ because all the trillion of dollars of QE money, which the Fed used to purchase zombie Mortgage Backed Securities from the too-big-to-fail Wall Street banks, came back to the Fed to earn interests and are not in circulation. (ie no increase in money supply).
Japan also resorted to QEs under Abenomics and the BoJ purchased about 7 trillion yen per month of Japanese government bonds, equivalent to about US$65 billion a month for two years after Abe came into office to raise the inflation rate to 2%.
According to Forbes “The U.S. has roughly 2.5 times more people than Japan. Based on this multiplier, the Japanese QE program equates to $162.5 billion, or 91% larger than the Fed’s program at its height.
But, according to IMF estimates, the U.S. GDP is 3.3 times larger than Japan. Based on that multiplier, Japanese QE equates to $214.5 billion per month, or 152% larger. “
Despite of that huge increase in money supply, Japan has gone through two recessions since Dec 2012 and two ‘Lost Decades’ sine you know when.
If more money can make an economy grow, then Zimbabwe will be richest in the world.
So how does the FED manage to keep the US dollar index high from its low of 70s in 2008?
Some say by manipulating the price of gold, which has plunged since its historic high in 2011, using paper gold (ETFs), as the dollar value goes in opposite direction to that of gold.
As to whether “this flexibility is abused” or not, just consider how is it possible for the total Derivatives Markets to be worth over an astounding 1.5 quadrillion dollars on Planet Earth today? When that collapses, who can bail it out?
4″If anything, the risk of deflation is prevalent in many advanced countries. This suggests that central banks have learned how to use fiat money well.”
If deflation is defined correctly as the decrease in money supply, then obviously there is no deflation at all. The ‘price deflation’ we see today in commodity prices like oil, copper, iron ore, nickel, zinc, rare earth etc could be due to a slow down in major economies like China, by far the largest consumer of commodities.
In the case of lower oil prices, it is the result of a pricing war by Saudi Arabia and its objective is to wipe out the shale oil competition in the US and to punish Iran and Russia, whose economies depend largely on the fortunes of oil and gas prices.
5 “If fiat money is more flexible and at the same time its possible side effect is absent, why should we go back to the straightjacket of the gold standard?”
It depends how much the paper money is pegged to gold. If it is pegged at US$35 an oz, like in 1944 at Bretton Woods, then obviously it would fail, like it did in August 1971.
There are about 170,000 tons of above-ground gold in the world today (not counting silver) and there is a steady increase of about 2,500 tons a year or an annual inflation rate of 1.5%, which is acceptable.
So how much should the ‘Super-Sovereign Currency’ suggested by Zhou be pegged to gold? The jury is still out. But according to Jim Sinclair, if gold is not manipulated by paper gold ETF and is emancipated, Gold will rise to US$50,000 an oz.
Update: The IMF Executive Board decided to include the RMB in the SDR as expected and a press statement has been released. The new formula will be used from 1 October 2016. The new weights are: 41.73 per cent for the US dollar, 30.93 per cent for the euro, 10.92 per cent for the Chinese RMB, 8.33 per cent for the Japanese yen and 8.09 per cent for the pound sterling.