China in the SDR

This comment is probably a week overdue. Let us hear what Ben Bernanke wrote on this:

If SDR inclusion is only symbolic, then what’s the big deal about the IMF’s decision? Well, the Chinese authorities, who very much want their country to be recognized as a global economic power, care a lot about symbolism. And SDR inclusion does recognize both the increasing economic power of China and the important steps the Chinese have taken over the years to open up their capital markets, to meet international norms in financial regulation, and to increase the extent to which market forces help determine the renminbi’s value. Recognizing China’s progress in these areas, and encouraging more progress, are reasonable steps for the IMF and the global community to take. [Link]

He is right that it is about symbolism. I do not know about the recognition part because I am not sure of what is being recognised. More on that a bit later.

It is true that currencies that are not part of SDR are being held by the global central banks as part of their Reserves – Canadian dollar, Australian dollar and the Swiss franc. That is why Bernanke is right when he says the following:

the dollar’s global status is a market outcome, not the result of a decision by any international body or of an international agreement. Private investors and governments freely choose to hold dollars because the markets for dollar-denominated assets are, by far, the deepest and most liquid of any currency; because the United States imposes no restrictions on capital flows in or out of the country; because of the quality of U.S. financial regulation; because the Federal Reserve has kept inflation low and stable for the past thirty years; and because the United States is large, prosperous, and politically stable.

We will grant Bernanke most of it. We do have big quibbles on his observation about the Federal Reserve keeping inflation low and stable. That is at best debatable and at worst, vastly overblown. But, the rest of his comments is, more or less, okay.

At the same time, one cannot rule out the possibility that China hopes for some purchases of the yuan by global reserve managers to help stabilise the yuan and clear the way for some more currency depreciation or devaluation. That is what I wrote here. I think yuan devaluation is still coming in 2016.

We will have to contest this statement of Bernanke below:

The underappreciated fact is that the direct benefits to the United States of issuing the dominant international currency are probably quite modest. It’s often argued, for example, that the dollar’s status allows the United States to borrow abroad more cheaply; but, in inflation-adjusted terms, the U.S. government does not enjoy meaningfully lower borrowing costs than other advanced industrial countries. We do benefit from the fact that much U.S. currency is held abroad, since these holdings amount to interest-free loans to our government; but other currencies, like the euro, are also widely held, and in any case the interest savings from foreign currency holdings are tiny compared to the overall U.S. government budget or the size of our economy.

Well, it is difficult for Bernanke to substantiate what he wrote there simply because the counterfactual is hard to establish. Would the United States have had to pay a much higher rate of interest for borrowing from international lenders, but for its global and dominant reserve currency status? In my view, quite likely or even most likely.

Given its post-Bretton Woods track record of steady depreciation, investors would have demanded a much higher risk premium to lend to America in US dollars but for its dominant status. It has helped and I wonder why he is underplaying it.

This article in Wall Street Journal Real-Time Economics argues that the IMF had cut corners for China. The article mostly cites those who were critical of the IMF decision to include the yuan in the SDR basket.

Professor Victor Shih of the University of California at San Diego thinks that non-transparency has been rewarded. He points out several unresolved questions about PBoC balance sheet.

The folks at ‘’ contacted two China experts to comment on this matter. One of them was Arthur Kroeber. He is a China bull. Yet, he was restrained. You have to read between the lines of a bull to know how much of a bear he/she is inside.

The other was Professor Zhiwu Chen, Professor of Finance at Yale School of Management. This is what he wrote:

We can see why fundamental reforms are out of the question if we follow the quick logic chain: maintaining the Party’s absolute control of economy/society is priority #1, far above and beyond everything else, for the current president —> SOEs must dominate economy —> banks and financial institutions must be controlled to serve the party and SOEs —> market principles must be restricted and capital in/out-flows cannot be free —> fundamental reforms continue to be talked about but not implemented, and structural imbalances cannot be corrected.

If the SDR inclusion had happened three or four years ago, more real reforms would have been possible. But, right now, too many burning challenges and downturn pressures are at hand (e.g., overcapacity, capital outflow pressure, difficulty to achieve growth target even after many policy interventions, pollution and environment, all financing tools/channels exhausted to the limit and beyond). So, short-term goals are far more dominating, making the SDR story more of a transitory news event. Reality will be back soon. [Link – emphasis mine]

Finally, according to this blog post, Bank of America-Merrill Lynch thinks that the yuan would depreciate by 3% to 4% in the second week of December, after the SDR basket inclusion. Perhaps, I think that it is appropriate that they have the last word in this blog post.


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