Source: Gold Money, by Stefan Wieler
At the latest G20 meeting, China’s central bank vowed to promote the use of SDRs in the Chinese economy, just four months after the IMF decided to include the RMB as part of the currency basket underlying SDRs. Adding the RMB marks only the 5th time the Fund changed the composition of the basket since formally moving away from a gold based system in 1974. However, as history shows, the SDR has been unable to maintain value as gold has. Adding the RMB to the basket will hardly change that.
On April 1, 2016, China’s central bank Governor Zhou Xiaochuan announced that the Chinese government will take actions to promote the use of SDRs in its domestic economy. The announcement was made at the end of a meeting of the G20 in Paris, which is hosted by China this year. China will start to use both the USD and SDRs when reporting its foreign reserves. In addition, the country will also consider issuing bonds denominated in SDRs. This comes five months after the International Monetary Fund (IMF) decided to include the Chinese Renminbi as a fifth currency to the basket of Special Drawing Rights (SDR) along with the U.S. dollar, the Euro, the Japanese yen and the British pound. The change takes effect on October 1, 2016. This marks the first major change of the constituents of the basket since 1981 when the IMF dropped 11 out of 16 currencies in the original basket. However, when the SDR was introduced in 1969, it was not based on a basket of currencies but linked to gold, 0.888671 grams to be precise, which, at the time, equaled exactly 1 US dollar. The SDR basket based on the original weighting of 16 currencies declined around 87.7% in value vs gold until today. Similarly, the basket introduced in 1978 has lost 84.4%. The smaller 5 currency basket introduced in 1981 is down 55.5% and the current basket is down 77.0% since its introduction in 2001.
Taking interest payments into account hardly changes the outcome. It is obvious today that for net holders of SDRs, breaking the link to gold had a negative impact on their reserve value. This is hardly surprising as any currency has underperformed gold over the past 10 years and any timeframe beyond that. Hence, it’s not that the currencies in the basket were Summary poorly chosen or poorly weighted, no combination would have managed to do better than gold, whether the RMB would have been part of the basket all along or not. While it is far too early to conclude that China is challenging the dollar’s dominant reserve position, RMB inclusion in the SDR will nevertheless have a profound impact on perceptions not only of China’s growing economic power generally but monetary power specifically. But while the impact of the inclusion of the RMB should not be underestimated, it is unlikely that this will change the trend that gold outperforms any fiat currency.
The IMFs Special Drawing Rights, the RMB and gold
In 1969 the International Monetary Funds (IMF) introduced the Special Drawing Right (SDR) in order to supplement reserve assets of member countries. At the time the US was tightening their monetary policy which meant there was a shortage of USD as a reserve currency and the hope was that the introduction of SDRs could alleviate the issue. An SDR is the equivalent of foreign exchange reserves for a member country. It can only be held and used by member countries, the IMF itself (which uses it as a unit of account), and certain designated official entities. It cannot be held by private entities or individuals – although private SDRs could be created and used, that market never developed. SDRs can be created only through an allocation by the Fund and the stock can only be reduced by a cancellation by the fund. An allocation gives the member country a low cost way to add to its international reserves. SDRs have played a minor role of global reserve assets in the past. In 2009 the fund sharply increased the allocation to the equivalent of SDR 204 billion (equivalent to about USD318 billion) as a response to the global financial crisis (see Figure 1).
Read More Here: The IMF’s Special Drawing Rights, the RMB and gold