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

China cut the central bank interest rate last week.

For the sixth time this year.

In addition, the Middle Kingdom lowered the amount of cash banks must keep in reserves.

The People’s Bank of The far east (PBoC) is trying to jump start their own slowing economy.

To put this in perspective, these are the most aggressive monetary policy steps from China since 08. During the financial crisis, China moved a massive 4 trillion yuan (AU$867 million) into its economy.

As an Aussie, you remember the benefits of that.

The thing is, the rate cut isn’t the news you should be paying attention to.

This is the in your encounter information that most mainstream experts will crow about over the in a few days or two.

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

As the trading world was digesting the speed cut, Bloomberg dropped this nugget of information:

‘International Monetary Fund representatives possess told China that the yuan is likely to join the fund’s basket of reserve currencies soon, based on Chinese officials with knowledge of the matter, a move that may help to make more countries comfortable while using unit or including it in their foreign-exchange holdings.

‘The IMF has given Chinese officials strong signals within meetings that the yuan is likely to earn inclusion in the current review of the Special Drawing Rights, the actual fund’s unit of account, stated three people who asked to not be identified because the speaks were private. Chinese officials are so confident of winning approval that they have begun preparing statements to celebrate the decision, according to two people.‘

If you haven’t heard about Special Drawing Rights before, let me explain.

Special Drawing Legal rights (SDRs), are an international form of cash created by the International Monetary Fund. SDRs derive their value from a weighted average of a basket of major currencies.

With SDRs, it’s important to remember they aren’t an actual currency. Rather they’re a ‘claim’ upon freely useable currencies for members of the International Financial Fund (IMF).

The idea of SDRs is to supplement currencies reserves of a specific country. Or they can be used to provide additional liquidity as needed.

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

First, they were created by the IMF within 1969, as a direct response to the limitations of gold and US dollar when paying international accounts.

And second, they are supported by nothing. No bullion, no assets and no commitment of the first born.

SDRs are nothing greater than a creation of powerful elites wishing to support the monetary system.

Including the actual yuan in the SDR basket, means the yuan’s become a credible, international currency.

And China, desperately wants to end up being invited to sit at the grown-ups desk.

Even though it’s just a rumour at the moment, Financial institution of America Merrill Lynch estimates the yuan could have a potential weighting of 13%.

At the last IMF evaluation in December 2010, the weighting share was divided unevenly in between four major currencies: euro 37.4%, Japanese yen 9.4%, pound sterling 11.3% and All of us dollar 41.9%.

The potential 13% yuan weighting would likely mean both the US buck and the pound sterling lose a significant portion of their share.

China attempted to have the yuan included at the last IMF meeting. But the IMF knocked them back, explaining the yuan didn’t satisfy the test of being ‘freely useable’.

Freely useable can have two meanings. To some, readily useable means ‘fully convertible’. That is, a currency which is highly fluid and free from state controls. Based on that definition, the actual yuan isn’t freely useable.

China places tight controls on how its residents use their money. There’s caps on how much citizens can take out of the country. International businesses must complete extensive paperwork before bringing any cash in. And foreigners are restricted, or limited to strict quota’s with regards to the country’s capital markets.

These factors haven’t changed in much five years.

But there’s another concept of freely usable. The IMF consider freely useable based on the utilization of a currency in international transactions. And whether it’s broadly traded on global marketplaces. So broadly speaking, the yuan right now meets the criteria. Being a fully convertible currency is only a benefit to be considered for SDRs.

The thing is actually, the use of the yuan and state regulates over the currency haven’t changed that much in five years.

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

Earlier in this year, there was some noise regarding China being added to the actual SDR basket. But the talk vanished. And then China spent the better part of 2015 devaluing its yuan against the US dollar.

Jim Rickards — the strategist of Currency Conflicts Trader — said many in the markets mistook this action as retaliation for not becoming added to the SDR basket.

According to Jim that’s not the case.

It’s a matter of when China will be permitted in the SDR basket. He reckons the procedure has been ‘elongated’. Telling subscribers:

‘China’s devaluation was not retaliation, but a necessary realignment to the Fed’s disastrous strong dollar policy. These policy moves are of the utmost importance to the functioning of the international monetary system.

‘They don’t happen from spite. These moves may surprise markets, but they are very carefully worked out behind the scenes. The 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 IMF’s December conference this year.

For investors, the outcome is that this:

‘The implications for investors tend to be profound. From now until next March, China includes a free hand to weaken the yuan somewhat further. That will put more deflationary pressure around the US, make the US buck stronger, and lead to added turmoil in US equity markets as earnings endure due to the strong dollar.‘

The move to add the yuan into the SDR basket can create more market turbulence in the US. Don’t think Australia is defense from this either. These behind the scenes movements are all part of the currency wars Jim analyses on a weekly basis. To discover how to capitalise onto it, go here.

Regards,

Shae Russell

Editor, Strategic Intelligence

From the Port Phillip Publishing Library

Special Report: If you want to get ahead in this world, it pays to have powerful friends within high places. With this brand new advisory, you’ll make one. A profile manager at the West Shore Group, and adviser upon international economics and monetary threats to the US Dod. Jim Rickards is no ordinary monetary newsletter writer.?And Strategic Intelligence is no ordinary newsletter… (more)