By JC Collins
With the announcement from the International Monetary Fund on renminbi SDR inclusion fast approaching, it is worth taking some time to review the fundamentals surrounding this all important event. Over the last few weeks I’ve focused much of the material here on the increase in RMB demand that will come after the announcement, as well as the impending interest rate increase from the Federal Reserve and the depreciating effects this will have on the USD and gold.
The potential for shifting wealth could be measured not just in the billions of dollars, but in the trillions. The overall effects of this huge monetary change are being minimized in the western media, as the script is being presented that the inclusion of the renminbi into the SDR will have little effect on the Chinese currency. Some are even going as far as to state that it will cause the RMB to depreciate further, even though the renminbi has already appreciated 10% against the dollar in the last 5 years.
There are a few factors which will determine the path forward, one of which is the actual weight the renminbi is given in the SDR composition. Another will be the interest rate increase by the Fed and China’s response to that increase. A response, which could in fact take place before the Fed’s announcement on December 16, 2015.
A few days ago US Treasury Secretary Jack Lew told Chinese Vice Premier Wang Yang that the United States supports the inclusion of the RMB into the SDR composition. Further discussions amongst the two also focused on China moving towards a more market-oriented exchange rate and implementing fiscal policies to boost domestic consumption.
All of those points fit into the thesis which has been presented here on POM on everything from the SDR decision, to the migration of the Chinese rural population into the ghost cities. The creation of a Chinese middle class over the next five years will amount to socioeconomic engineering of the highest order.
It is increasingly obvious that the inclusion of the renminbi into the SDR will be a fundamental change in how the international monetary system is structured. But at what weight will this inclusion take place?
Based on China’s share of global exports, foreign exchange reserves, and existing use of the renminbi in global capital flows, it has been determined that the SDR weight of the RMB could be in the 14% to 16% range.
This would put the Chinese currency above the British pound and Japanese yen in the basket, but still below the US dollar and euro. Such a scenario, based on existing data, will increase the SDR interest rate by 22 basis points and trigger significant portfolio rebalancing towards renminbi financial markets.
This shifting of billions and trillions of dollars will begin immediately after the announcement and will pick up momentum in the lead up the actual effective date of the new SDR composition, which will be sometime next October.
See yesterday’s post The Mystery of the October SDR for a review of how renminbi demand will mean a decrease in USD demand, and how this loss will be off-set by changing money market rules to force a shift into government bonds. These rules are set to take effect next October, the same time as the new SDR composition takes effect.
Considering that China will not continue the monetary policy of linking to the policies of the Federal Reserve, we could very well see an ending of the USD peg correspond with the announcement from the Fed on the first interest rate increase in ten years.
With the peg maintained, any interest rate increase by the Fed will put depreciating pressure on the renminbi. But if the managed peg is ended at the time interest rates increase and the SDR announcement is made, the capital in-flows into RMB capital markets and subsequent appreciation of the renminbi will be all but certain.
This change in capital flow and currency value will facilitate the start-up of both the BRICS Development Bank and the Asian Infrastructure Development Bank. These institutions will fund the massive infrastructure development which the emerging economies are about to begin. This development will spur a new commodities boom and all investments tied to the renminbi, commodities, and mining will see appreciations over the coming years. See post The Coming Commodities Boom for more information.
With so much else going on surrounding the USD, the renminbi, and the SDR, it is easy to forget the 2010 Quota and Governance Reforms which the US Congress has failed to implement. The Plan B by-pass of the US on this matter is expected to be initiated on December 15th, the day before the Fed announces whether or not it will increase interest rates.
How this by-pass will look has been debated. There could be an SDR2 type situation which is built on the structure of the Chiang-Mai Initiative Multilateral. The CMIM could be transformed into an Asian Monetary Fund which is subservient to the International Monetary Fund and would use the SDR2 as its primary asset. See posts Meet the Asian Monetary Fund and Introducing the Alternative SDR2 for more information.
Either way, the end of this year is shaping up to be extremely exciting from a monetary reform point of view. The changes, and potential changes to how the international monetary system functions, and is structured, is the back story to what is happening geopolitically on the world stage. – JC