After the SDR Announcement – Now What? (FREEPOM)

Economics, FREEPOM

Widening of the Trading Band, US Yuan Clearing, and Increasing Interest Rates

By JC Collins

A major piece of the POM analysis has fallen into place.  As has been predicted here for the last two years, the Chinese renminbi has been added to the Special Drawing Right basket of the International Monetary Fund.  This fundamental change in the composition of the SDR will allow for a more sustained and balanced adjustment to the international monetary system.

This first step towards stabilizing the global system will spur renminbi liquidity growth and begin the process of foreign exchange reserve diversification.  This diversification will ease the international pressure which has been fostered upon the US dollar in its role as primary reserve currency.

Though it will still take years for RMB denominated reserves to equal USD denominated reserves, the process itself will proceed at a faster pace than many other analysts and economists will predict.

For the last few years many expressed their conclusion that the RMB would not be added to the SDR composition.  Now that it has been added these same analysts and economists are attempting to minimize this change by stating that it will take years for the renminbi to equal the dollar in both trade and reserve accumulation.

The growth in RMB liquidity will likely surprise many as massive infrastructure investment projects are funded by the Asian Infrastructure Investment Bank and BRICS Development Bank through loans denominated in yuan.

On top of that, it is now being reported that the US will be setting up a yuan trading and clearing facility which will allow US institutions to make yuan payments.  This action is being supported by all the major players in American banking, business, and other financial institutions.

This integration between international reserve currencies will allow for the further stabilization of the monetary system.  As Managing Director of the IMF, Christine Lagarde stated today:

“The Executive Board’s decision to include the RMB in the SDR basket is 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 continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy.”

Moving forward we can expect to see the People’s Bank of China to continue widening the trading band of the yuan against the dollar.  This widening will allow for the appreciation of the RMB in the months to come.

As the Fed moves the world back into an environment of increasing interest rates, the US dollar will begin the process of depreciating against the currencies of its largest trading partners.  The expanding RMB market will allow this depreciation to take place while minimizing volatility in the international monetary system.

There is so much more to come in this multilateral monetary transition.  In the meantime I would encourage all new readers to visit the previous posts where these topics were covered in greater detail.  – JC

Renminbi SDR Weight and the End of the Dollar Peg

The Mystery of the October SDR

Fed Rate Hike in a Changing World

Renminbi Demand is About to Explode

The Case for Increasing Interest Rates and Depreciating the Dollar

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