This week brought the highly anticipated announcement that China’s currency will be included in the basket of currencies used by the International Monetary Fund in its Special Drawing Rights (SDR). If you were a little embarrassed not knowing what SDRs are or why they are important, don’t feel bad. That acronym will fade from everyone’s memory soon and you won’t have to worry about it coming up during small talk at holiday cocktail parties.
Not to downplay its gravitas, the importance of this week’s announcement is not an immediate shift in the financial center of gravity but, rather like a commuter successfully navigating downtown LA freeways, the driver didn’t crash but still has a long way to go to complete the journey on the streets.
The SDR is little more than an accounting concept designed to help maintain a standard for valuations of IMF member countries assets and liabilities. It does not confer “reserve currency” status as typically referred to in financial reporting. Such status is gained once there is a massive voluntary shift by individual countries to buy the yuan with sovereign funds. That can be seen by the fact that the FX rate barely moved on the announcement.
But the responsibilities China now has going forward are quite significant. China has been on a steady march to internationalize its currency, with most of the progress coming in small but frequent changes in the operational world of payments processing and capital markets development. This move underscores China’s recent announcement that it will complete its currency liberalization by 2020.
This liberalization will have definite impacts on how the U.S. interacts with China. In conjunction with Monday’s announcement and the recent state visit by People’s Republic of China President Xi Jinping, a new working group was announced that will push the financial evolution of the yuan in the U.S. This group includes Michael Bloomberg, Henry Paulson, Tim Geithner and Mary Schapiro, so it is certainly looks serious on paper.
My View: In addition to being a significant step, this puts China on a more permanent path to liberalizing its currency, and an important milestone on its road to being a fully developed financial system.
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