My inbox is filling up — again — with people asking about the collapse of the U.S. dollar in October.
In that fateful month, the IMF will vote on including the Chinese yuan in the basket of currencies that make up its special drawing rights (SDRs). It will most likely earn that spot, and in my opinion, it should. For other member currencies, including the U.S. dollar, that will mean representing a smaller portion of the SDRs than they did before.
Now, many people are claiming that this is the point when the dollar will suffer a fatal wound, shrink from the world stage, lose its value, and drain people’s wealth in the process. I don’t see it that way. It’s not a challenge to dollar supremacy. And it won’t cause the dollar to fall in value.
The IMF set up SDRs to act as a buffer for member nations when their currencies come under pressure. If a country’s currency wanes, it saps the nation’s ability to buy goods in the global marketplace. That can disrupt food supplies and trade in general. To combat this, each member country holds a certain amount of SDRs that act as a reserve for times of need.
To be included in the SDRs, a currency must be used in foreign exchange, have sufficient transaction volume in derivative markets, be used as a reserve by foreign central banks, and have interest rates set by market forces. The currencies in the SDR today — the U.S. dollar, the Japanese yen, the euro, and the British pound sterling — meet most of these criteria. The Chinese currency does not, but that won’t matter.
While the yuan is used to buy goods from China, they aren’t widely represented in derivative markets or held by many central banks. Chinese interest rates are set by the government, but so are interest rates around the world, so it’s hard to hold that one against them.
The Chinese yuan will leapfrog more commonly held and traded currencies like the Canadian loonie or Australian dollar because the country has the second largest economy on the planet, is the world’s largest export nation, and has a trade surplus. Their efforts to increase the yuan’s presence in international trade and finance over the past few years justifies the currency’s allocation in the SDRs. They sell lots of stuff to lots of other people, so it makes sense that other countries would have a smidge of Chinese money floating around if things got tough in their home currency.
But it’s only a smidge. The SDRs were created in 1969. Since that time, the IMF has allocated roughly $280 billion worth of the units to member countries. Just $280 billion. Currently U.S. dollars represent around 40% of SDRs, so roughly $115 billion dollars are included in all the SDRs that exist today. That’s it.
Consider that over $5 trillion worth of currency transactions occur every single day. Among all transactions, the U.S. dollar is party to more than 40% of them. It’s also the most widely held currency in central bank reserves, representing over 60% of all declared holdings. And let’s not forget the U.S. Treasury market is the deepest and most liquid bond market in the world.
Given all of this, it’s hard to see how adding a new name to the SDRs will change anything that happens in the real world. It’s not a thorn in the dollar’s side. It’s not even a thorn.
But it does give us something to talk about for a while. Just like July 2014, when many claimed FATCA would threaten the U.S. dollar, October 2015 will be another drop dead date when the dollar will simply refuse to bow to the final curtain.
So hang on to your greenbacks. They’re still the strongest currency in town, no matter how badly the Fed or U.S. government treats them. And it’s going to stay that way for some time.
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