The big test of China's legitimacy ..... surely it's only a matter of time.

Wednesday 6th May 2015

The big test of China's legitimacy ..... surely it's only a matter of time.

 

"Beijing must clear four hurdles to enter IMF currencies club" , The Financial Times , p.7

see also

"China set to assume even larger weight in crucial global indices" , The Financial Times , p.30

What may seem on the surface something of a dry, technical matter is actually one of huge importance for the future, both economically and geopolitically speaking. The IMF will meet to decide whether to endorse China's currency, the Renminbi, in its list of reserve currencies alongside the US Dollar, the Euro, the Yen and Sterling, and thus include it as a constituent of its currency basket of Special Drawing Rights (SDR's).

 Given China's meteoric rise and economic muscle this might seem a no-brainer. China has argued since the financial crisis of 2009, and it has a point, that the system is over-reliant on the US Dollar and could benefit from reshaping. But there are other factors afoot here. The inclusion of the Renminbi would not only bring greatly increased influence in the global monetary system, but would also be of great value to China's geopolitical ambitions. This would not sit too easily with the US, who will likely insist that the four tests to be overcome before inclusion are rigidly applied. Three of these, concerning the volume of market transactions in the currency and its desirability as a reserve currency for central banks, should not present too many problems. The fourth, which requires greater financial liberalisation and essentially boils down to whether interest rates are market-based or government controlled, is harder to call. China has made some moves in this area but they may not be enough.

The effects of a decision to include the Renminbi ? Well, if Japanese currency liberalisation in the 1980's is anything to go by, we could see a rush into Chinese assets. Bearing in mind that many of these are already trading at eye-wateringly high levels, that's a little scary. On the other hand, countries struggling with huge trade deficits such as the US and UK for example (see below) might welcome the prospect of a weaker currency. Which way will the decision go ? Well, the IMF is obliged to examine this issue at least every five years, and may choose to fudge the matter by promising to look at things again before 2020. But, as we said, it's surely just a matter of time.