The International Monetary Fund has officially designated the Chinese yuan a global reserve currency. What does it imply for the gold market?
On Nov. 13, IMF Managing Director Christine Lagarde backed the inclusion of the yuan, saying that the currency became “freely usable” and thus met the fund’s criteria. Yesterday, the IMF’s Executive Board, which represents the Fund's 188 members, approved the inclusion of the yuan in the reserve basket, known as Special Drawing Rights. What does it mean for the global economy?
The IMF’s move is primarily a prestigious victory of Chinese authorities on their way to elevate the country’s economic role in the global economy. The yuan joined the elite group of currencies – the U.S. dollar, the Japanese yen, the euro and the British pound – so it is an important symbolic change in the global monetary system.
However, the significance of the yuan’s inclusion into the reserve basket goes beyond the symbolic dimension. The IMF’s decision will likely spur an international demand for the yuan. Economists predict that the yuan’s new status could boost demand up to $1 trillion over the next five years. Moreover, the decision should encourage China to conduct more free-market reforms and liberalize the financial and capital account.
How will the IMF’s move affect the gold market? On the one hand, the yuan’s inclusion in the SDR basket is positive for the yellow metal as it undermines the U.S. political and economic dominance around the world. However, at this point the IMF’s decision has more of a symbolic effect than practical importance and will not threaten the dominance of the U.S. dollar. Indeed, the new weightings show that the euro will see the biggest drop to make way for the inclusion of the Chinese yuan. The yuan will have a 10.92 percent weighting. The U.S. dollar's weighting will fall to 41.73 percent from 41.9 percent, the euro's weighting to 30.93 percent from 37.4 percent, the pound to 8.09 percent from 11.3 percent, and the yen to 8.33 percent from 9.4 percent. Investors should remember that the SDR basket creates no formal obligation on the part of the IMF’s 188 members to hold a similar proportion of international reserves.
On the other hand, the change in the yuan’s status will be negative for the shiny metal as it increases competition in the global reserve currency market. Gold has had to compete with four currencies as a global reserve so far, but from October 2016 (when the yuan will be effectively included in the reserve basket) it will have to compete with five currencies.
The take-home message is that the IMF will include the yuan as a global reserve currency from October 2016. The consequences for the gold market are uncertain. The challenged position of the U.S. dollar should be positive for the shiny metal, but the yuan’s inclusion into the SDR mechanism increases competition in the global reserve currency market. The precise impact on the gold market in the future will depend on the source of inflows into the yuan. If investors shift their funds from the greenback into the yuan, gold will shine, but if they replace gold with Chinese currency, the opposite will be true. Given that the U.S. dollar-denominated reserves are so large relative to other currencies, the greenback may face a greater downward pressure, which would be positive for gold.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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