Why Adding China to the SDR Basket is Part of the Currency War

China cut the central financial institution interest rate last week.

For the 6th time this year.

In addition, the center Kingdom lowered the amount of money banks must keep in reserves.

The Peoples Bank of China (PBoC) is attempting to jump start their slowing economy.

To put this in perspective, these are the most intense monetary policy measures through China since 2008. During the financial crisis, China pumped a massive 4 trillion yuan (AU$867 billion) into its economy.

As an Aussie, you remember the benefits of which.

The thing is, the rate reduce isnt the news you should be paying attention to.

This is the in your face information that many mainstream analysts will crow regarding over the next week or two.

However the real news for China, is hardly getting a mention.

As the investing world was digesting the rate cut, Bloomberg dropped this nugget of information:

International Monetary Fund representatives have told China that the yuan is likely to join the actual funds basket of reserve currencies soon, according to Chinese officials with knowledge of the matter, a move that may make more countries comfortable using the unit or even including it in their foreign-exchange holdings.

The IMF has given Chinese officials powerful signals in meetings that the yuan is likely to win inclusion in the present review of the Special Sketching Rights, the funds unit associated with account, said three individuals who asked not to be recognized because the talks were private. Chinese officials are so assured of winning approval that they have begun preparing statements to celebrate the decision, according to two people.

If you havent heard of Special Sketching Rights before, let me explain.

Special Drawing Rights (SDRs), are a global form of money created by the actual International Monetary Fund. SDRs derive their value from a weighted average of a basket of major currencies.

With SDRs, its important to remember they arent an actual currency. Rather theyre the claim on freely useable currencies for members of the International Monetary Fund (IMF).

The idea of SDRs would be to supplement currencies reserves of a particular country. Or they can be used to provide additional liquidity if needed.

But there are two key things you need to know about SDRs.

First, they were created by the IMF in 1969, as a direct response to the limitations of gold as well as US dollar when having to pay international accounts.

And second, they’re backed by nothing. Absolutely no bullion, no assets and no promise of the first born.

SDRs are nothing more than a creation of powerful elites wanting to prop up the monetary program.

Including the yuan in the SDR basket, means the yuans become a credible, international currency.

And China, desperately really wants to be invited to sit in the grown-ups table.

Even though its just a rumour right now, Bank of America Merrill Lynch estimates the actual yuan could have a potential weighting of 13%.

At the final IMF review in December This year, the weighting share was split unevenly between four major foreign currencies: euro 37.4%, Japanese pound 9.4%, pound sterling 11.3% as well as US dollar 41.9%.

The possible 13% yuan weighting would likely mean both the US dollar and the pound sterling lose a significant portion of their reveal.

China tried to have the yuan included in the last IMF meeting. But the IMF knocked them back, explaining the yuan didnt satisfy the test of being freely useable.

Freely useable can have two meanings. To some, freely useable means fully convertible. That is, a currency which is highly liquid and free from state controls. Based on that definition, the actual yuan isnt freely useable.

China places tight controls on how its citizens use their money. Theres caps how much citizens can take out of the country. International companies must total extensive paperwork before getting any cash in. And people from other countries are restricted, or restricted to strict quotas when it comes to the countrys capital markets.

These factors havent changed within much five years.

But theres another meaning of freely usable. The IMF consider freely useable based on the utilization of a currency in worldwide transactions. And whether its broadly traded on global marketplaces. So broadly speaking, the yuan now meets the criteria. Being a completely convertible currency is only an advantage to be considered for SDRs.

The thing is actually, the use of the yuan and state regulates over the currency havent changed much in five years.

Adding the yuan to the SDR basket gives the currency the credibility its leaders so desperately want.

Earlier in this year, there was some noise about China being added to the SDR basket. But the talk disappeared. After which China spent the better a part of 2015 devaluing its yuan against the US dollar.

Jim Rickards the strategist of Currency Wars Trader stated many in the markets mistook this action as retaliation for not being added to the SDR basket.

According to Jim thats not the case.

Its a matter of when China will be allowed in the SDR basket. He reckons the process has been elongated. Telling subscribers:

Chinas devaluation was not retaliation, however a necessary adjustment to the Feds disastrous strong dollar policy. These policy moves are of the most importance to the functioning of the international monetary system.

They dont happen out of spite. These moves may surprise markets, but they are carefully worked out behind the scenes. The actual elites see it coming; the everyday investor does not.

Jim says investors must be aware China will be included to the SDR basket at the IMFs Dec meeting this year.

For investors, the end result is this:

The implications for investors are profound. From right now until next March, China has a free hand in order to weaken the yuan somewhat further. That will put more deflationary pressure on the US, make the US dollar stronger, and result in added turmoil in US equity markets as earnings suffer due to the strong dollar.

The move to add the yuan into the SDR container will create more market disturbance in the US. Dont think Australia is immune from this either. These types of behind the scenes movements are all area of the currency wars Jim analyses on a weekly basis. To discover how to capitalise on it, go here.

Regards,

Shae Russell

Editor, Strategic Intelligence

From the Port Phillip Posting Library

Special Report: If you want to get ahead nowadays, it pays to have powerful buddies in high places. With this new advisory, youll make one. A portfolio manager at the West Shore Group, and adviser on international economics and financial threats to the US Department of Defense. Jim Rickards is no ordinary financial newsletter writer.?And Strategic Intelligence is no ordinary newsletter (more)