Tuesday, May 3, 2016

David Marsh (OMFIF) - China Accelerates SDR Bond Platform

David Marsh of the OMFIF has released a new commentary suggesting that China is moving ahead with steps to create SDR bonds. He describes it as a slow and steady process. Below are some quotes from his new commentary.


"China appears likely to speed up promotion of the International Monetary Fund's special drawing right under a plan to prepare a platform this summer for SDR borrowing by Chinese and foreign entities on China’s onshore capital market.

The initiative will help fulfil several strategic Beijing monetary and economic objectives. These include boosting international acceptance of the renminbi, which enters the IMF’s composite currency unit in October with a weighting of around 10.9%, joining the dollar (41.7%), euro (30.9%), yen (8.3%) and sterling (8.1%) as officially recognised reserve currencies.

Beijing’s SDR capital market initiative will allow domestic Chinese investors to subscribe to domestic bond issues with a significant foreign currency component, a means of helping dampen capital outflows that have gained prominence in the last 18 months as a result of progressive capital liberalisation.

The SDR borrowing platform seems likely to be set up as early as July, earlier than expected, in advance of the Chinese currency’s formal SDR adherence. This will necessitate creating a synthetic SDR that can be related, through forward pricing, to the ‘new’ SDR being created in October. This step could lead the IMF to update its procedures for fixing the SDR, which at present is set daily, but in future may need to be established on a 24 hours a day basis."

. . . . . .

"The Chinese SDR initiative, depending on the market response, could allow the SDR to become a currency in its own right, rather than an artificial, narrowly used aggregation of leading currencies. But this is a long journey that faces many hurdles and may never be completed.   . . . . . "

"Zhou Xiaochuan, governor of the People’s Bank of China, has been the public face of Beijing’s SDR campaign. He said at the end of March in Paris that China intended issuing domestically orientated SDR-denominated bonds to promote the composite currency’s use.

A nascent market in SDR bonds started in the early 1980s but never took off, because of the wide gulf between the official use of the SDR as a reserve currency unit and the virtually non-existent private market for the SDR in market transactions. As a result of latest Chinese action, the gap could narrow in future years."

My added comments: Please note that while Mr. Marsh says this initiative is happening sooner than expected and "could allow the SDR to become a currency in its own right", he adds that "this is a long journey and faces many hurdles." Once again, this is in line with what we have been reporting here. 

The wild card that is always out there on this issue is if we do get another major financial crisis worse than 2008 as some are predicting. We can expect based on all the evidence we have presented here that this would lead to a global proposal to use the SDR as a new global reserve currency to replace the US dollar under "new rules of the game." Without a crisis like that, all the evidence so far indicates the process would unfold gradually rather than quickly.

Another note to add here. There has been a ton of speculation in the alternative media that China is about to officially back the yuan with gold and refuse to exchange the gold backed yuan for US dollars. This appears to be based on an unsubstantiated report on this site. It seems to have been accepted as true by many on alternative media sites despite no confirmation of this on any mainstream media and no indication from any Chinese official that anything like this has actually happened. 

All the available public evidence from China indicates that they support the SDR as an eventual replacement for the US dollar as the leading global reserve currency, but in a process that would unfold over a long time period (as David Marsh describes in the commentary posted above). China is definitely building up its gold reserves a lot, but has not stated in public that they intend to use the gold to officially back the yuan. This has led to speculation by some that China secretly intends to do this at some point and the unsubstantiated report linked just above created a stir for some who take this view. If you look at the update to the original report, it states that the original story is still unconfirmed. (see update 4-19-16 - "No word yet on a gold-backed Yuan currency."). It's now past the end of April with no further update. I do not find any credibility for this report at this point in time.

Jim Rickards says that China is simply building up gold reserves to hedge the very large US dollar position in their official reserves and to prepare for an eventual global "reset" conference where the "rules of the game" will be changed for the global monetary system. He says each country will need gold reserves at that time to be a serious player in those discussions which explains the big buildup of gold reserves by both Russia and China.  We will follow this over time and see what actually does happen

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