Tuesday, December 9, 2014

The Biggest Monetary Issue in 2015 that is Flying Under the Radar?

Our goal here is to encourage people who roll their eyes when someone starts talking about an IMF workpaper to actually pause for a moment to think about why it might matter to them. Don't worry, readers won't be asked to read all the fine print in the articles linked below in this blog post. Our job is to do that and try to sift through it all to create an 'executive summary' for readers. The idea is to get to the bottom line of what is important and why it is important without drowning in pages of technical jargon. 

In the title above we asked: What is the biggest monetary issue in 2015 that most people aren't aware of?

Before we dig into this, let's just answer the question plainly. The biggest monetary issue in 2015 may very well be the inclusion of the Chinese Yuan into the basket of currencies that make up the SDR used at the IMF. Say What? That already sounds pretty technical.  And why does that matter to me? Let's try to break it down.

First let's define some basics. The SDR is the unit of measure used at the IMF (here is our earlier blog post about them). It's not a real currency, but nations think of it like money. Everybody at the IMF kicks in some chips to be a member. Those chips are divided up between the members based on their quota share. The quota share is determined based on several factors like how big the economy is for each country, etc. Bottom line: The bigger and more influential your economy on a global scale, the bigger your quota (the more SDR chips you get). 

Members cannot use SDR's in the real world economy (its an inside the IMF thing). But they can convert their SDR's into actual national currencies and spend them. So, of course, nations want as many of them as they can get. I wouldn't mind having some myself even if I can't spend them anywhere today.

Member nations can borrow against their quota. Other members can loan out their quota (and earn interest). The bigger your quota, the more you can borrow if you need to. So you see why its pretty important to get as big a quota as you can. The US typically is a lender and gets interest. Places like the Ukraine are hoping to borrow as much as they can.

The SDR unit today is made up of a basket of four currencies (the US dollar, the British pound, the Yen, and the Euro). Their are certain criteria you have to meet to get your currency included in this basket. Being in the basket denotes prestige, power, and influence globally. This is why China badly wants the Yuan to be included in the basket. The basket comes up for review in 2015. The big question is: Will the Yuan meet enough criteria to get included in the SDR basket? The answer to that question may well be the biggest monetary issue in 2015 that no one (except monetary system geeks who follow all this) knows about.

China has been working feverishly to get the Yuan in position to get into the basket in 2015. You can read this very long article about that or just take my word for it. Assuming you choose the latter option, here are some key things China has been doing to get ready: 

-expand the use of the Yuan in international trade and commerce

-create offshore Yuan clearing banks in Australia, Canada, the UK, Germany, France, Luxemborg, South Korea, and Qatar.

-increase domestic gold reserves to diversify and stabilize backing of the Yuan

-taken steps to encourage Central Banks to include the Yuan in official reserves

-taken steps to get a bond market denominated in Yuan going forward

-taken steps to get the Yuan to be recognized as a "freely usable currency"

Why is it important to do these things? Because these are the criteria the IMF uses to decide if your currency gets added to the basket. Here is the actual language that talks about that:

"The SDR basket comprises currencies that are issued by Fund members (or by
monetary unions that include Fund members), whose exports of goods and services
during the five-year period ending 12 months before the effective date of
the revision had the largest value, and that have been determined by the Fund
to be freely usable currencies."

But what is a "freely usable" currency? It is this:

"A freely usable currency means a member’s currency that the Fund determines (i)
is, in fact, widely used to make payments for international transactions, and (ii) is
widely traded in the principal exchange markets."

Why these criteria? Because the currency needs to be widely enough used and held so that members can easily exchange it. It needs to be liquid and widely accepted. To use it, people need to accept it all around the world. That is why most nations use the US dollar and the Euro for this now.

Now, Back to our original title for this article. Why would inclusion of the Yuan in the SDR basket in 2015 be any big deal?     Why Should I Care about that?

It would be a big deal because it is a key signal to the world that the existing global monetary system is changing. It opens the door for more influence, power, and prestige for China (and eventually the other BRICS nations). The Chinese are working day and night to get this done because they know it's a big deal. For US citizens, think about this. If the the US dollar is currently the most important currency in the basket and and is weighted at about 42% of the total, what do you suppose will happen to that share if the Yuan enters the basket?

I am not a math genius, but I suspect the US dollar share will drop along with the other three in the current basket to make room for the newbie in the basket. (Keep in mind it was just reported that China will soon pass the US as the largest economy in the world)

But I don't use SDR's for anything. Why Should I Care if this ratio changes?

Answer: You don't use SDR's today at the grocery store. But the value of the dollars you do use has more purchasing power because it is the Big Dog in the current SDR basket. You may not care about SDR's, but nations and Central Banks do. If Jim Rickards is right and another global crisis leads to the IMF becoming the new global Central Bank, the SDR will matter a lot to you then. A reset of the value of various currencies in relation to the SDR could impact you directly in terms of what your dollars will buy. 

What about gold you ask? If gold factors into any reset the IMF has a big pile of it and has no debt. The US also has a big pile of gold, but has a gigantic load of debt offsetting it. So the advantage goes to the SDR over the US dollar if gold becomes a factor.

So, it becomes obvious why China wants the Yuan in the basket. They see a future like Jim Rickards predicts. They want to be a major player at the table with their chips recognized alongside the big boys. Keep this in mind when you see all the talk about the new BRICS Bank and the BRICS taking on the existing global financial system. On the surface what looks like conflict may really just be an effort to get more leverage within the IMF. Otherwise, why is China working so hard to get into the SDR basket next year? (they have spent years working on this). Because they are planning to walk away from the IMF? I doubt it.

A huge key to watch for in 2015: Does the Yuan make it in the SDR basket?    

I think it will because the IMF may be able to do this without the approval of the US Congress and it is a way to pacify the BRICS for not getting the 2010 IMF quota reforms passed. China will very likely overlook that issue if they get the big prize; inclusion of the Yuan in the SDR basket. It will be proof that the monetary system change we talk about here is happening. And you probably won't care in 2015, but someday you probably will. 

Imagine if someday you owned a currency that was directly tied to the SDR (and carried the same level of system backing) that you could use anywhere in the world instantly with any mobile phone. But that's a topic for another day in the future.

Update 12-12-14: Bloomberg runs an article on this topic. We will have a blog post reviewing this article on Monday (Dec 15th).

Update 12-16-14: Silver Doctors runs this article on their site today. You can see it here.

added note: 

A question I get here is how can the average person prepare for change given that so many different future scenarios are possible? On January 1st 2015 I will have an in depth article that talks about this. It will give the history for why this blog was started, what it hopes to do, and offer some common sense ideas that anyone should be able to use to prepare for whatever happens. This article will also be provided as a Google document in Word format so that it can be easily printed and given to anyone interested. Of course it will be free to anyone who can use it. Please do hand it out to anyone you think can use it.

No comments:

Post a Comment