If U.S. conservatives are to stop yuan becoming part of special drawing rights, they need to find allies
In April, the Asian Infrastructure Investment Bank, a Chinese initiative, attracted widespread support from countries around the world. On Aug 11, the announcement of an initial 2 percent depreciation of the Chinese yuan had an immediate impact on global markets, driving stocks and Asian currencies down, and sparking speculation about further monetary easing in China as part of a new package of economic stimulus.
Near the end of this year the board of the International Monetary Fund will meet to consider whether the yuan should join the U.S. dollar, the euro, the British pound and the Japanese yen to become part of the IMF's own currency, the special drawing rights.
A preliminary IMF staff report on the five-year SDR review, published in early August, said the IMF board's decision, which requires a 70 percent voting majority to become law, will be based more on politics than economics. Will the major developed countries, led by the United States, welcome China into the inner circle of global leaders?
The previously quite obscure IMF SDR has suddenly turned into a hot topic. The SDR has become a touchstone for how and when China joins the inner-circle global club long dominated by the other victors of World War II－the United States, Canada, Britain, and France－with Germany, Italy and Japan as later members. The inner-circle club, known today as the G7 countries, has used its dominant combined share of world economic output to control global decision-making. The G7 club has allowed Russia in as an observer, but it has kept China out.
When in 2013 China first floated the idea of an international infrastructure bank that could provide finance to Asia, most observers expected only Asian countries to be interested. But by this June the new investment institution had 57 members drawn from developed and emerging countries. This strikingly demonstrated China's importance as a global economic and cultural force. But the U.S. has not joined the AIIB. Nor have two of its closest allies, Japan and Canada.
In 2010 the IMF board agreed on a change in ownership structure and voting rights that recognized the growing contribution to the world economy made by the emerging countries, led by China.
Under the new rules, China's voting participation in the IMF was in effect doubled, from 3 percent to 6 percent. The IMF ownership reform was approved by every national government, except that of the U.S.. Last year the U.S. Congress voted against the reform, and on June 30 the final deadline passed for U.S. ratification of the change.
Conservative opinion in the U.S. is set against accepting China's rise to global leadership status. For example, a recent article by Edwin Truman of the Peterson Institute for International Economics, a Washington think tank, argues against China's membership of the SDR now. Given the powerful influence of the U.S. around the world, this opinion carries weight when it comes to deciding whether China's currency should join the IMF's currency basket.
The SDR was created in the 1960s as an important part of the machinery used to control the global economy. It is made by the IMF from fixed proportions of the four major currencies, with the dollar and the euro accounting for about 85 percent, and the remainder from the Japanese yen and the British pound.
The SDR was designed as a means for the IMF to provide liquidity to a country in financial trouble, like Greece is today. It forms part of the foreign reserves of a country's central bank, underpinning that country's currency.
Stability, credibility and liquidity are the essential characteristics of the SDR, which is issued by a global organization backed by the credit and good faith of its members.
There are two criteria for a currency to be a part of the SDR: The currency's share of world trade and its international "usability" or liquidity. It is clear that for China, the world's largest exporter and second-largest importer, the test of world trade is easily met.
But what about usability? Some think that usability means convertibility. But, as the IMF points out, a currency with some capital controls can be widely usable, while a fully convertible currency may not be widely used.
Usability does not mean convertibility, but popularity. The IMF has worked out a range of tests for usability, some based on history, others based on an updated perspective including private capital flows as well as official trade. The IMF recently published the result of its usability tests, both old and new, for the yuan. They were equivocal. Obviously it has become much more important in world trade and finance over the past few years.
On the other hand, it still occupies a small share, only around 2 percent, of international financial transfers, financial foreign exchange trading and internationally held debt. Here the dollar and the euro still reign supreme.
The judgment that the IMF directors have to make this year is whether the yuan's fast progress in recent years, from a low base, represents a durable trend toward a major international currency, to which they should respond now. Another key judgment to be made is whether the yuan's international value is determined by the market. A move toward market determination was one of the reasons for China's unexpected decision on Aug 11 to allow the yuan to depreciate. Along with recent steps to open market access, and allow the market to determine Chinese interbank interest rates, will this be enough to persuade the IMF to include the yuan as part of the SDR?
The decision comes back to politics. The refusal of the Republican-dominated U.S. Congress to ratify the IMF voting changes decided on in 2010 is not encouraging. Can the powerful American constituency opposed to recognizing China's new place in the world prevail against many other countries that feel China's new importance must be recognized? The decision to include the yuan in the SDR requires an IMF board majority of 70 percent. Canada, Japan and the U.S. between them have 25.2 percent of the IMF votes. This is less than the 30 percent they need to control the vote. To block the yuan as a component of the SDR, they need additional support.
The traditional U.S. ally, Britain, showed its independence in Chinese matters in April when it became the first major European country to apply to join the AIIB, against the wishes of the U.S.. In the IMF later this year, Britain will probably vote to support China's membership in the SDR. The Americans will have to look elsewhere for the blocking votes.
Perhaps, though, good sense will come to the aid of the U.S.. Washington may decide that it is time to welcome China into its exclusive club. China may wake up some time in November to discover that the yuan has become part of the SDR. The new world order will evolve smoothly from the old.
If not, in a few years the Americans will discover that, while they cannot prevent the world order changing, they can erode their power to influence the speed and direction of its change. That would be a pity both for the U.S. and for China.
The author, Giles Chance, is a visiting professor at Guanghua School of Management, Peking University.
