We have already written that the International Monetary Fund has officially designated the Chinese yuan a global reserve currency. However, because there are still a lot of misunderstandings about the impact of this event on the global currency market and the price of gold, we will examine this issue in more detail.
The yuan’s inclusion into the reserve basket aroused conflicting opinions. Some analysts say that the IMF’s move will undermine the U.S. dollar, while others point out that the China’s share of the SDR comes primarily at the expense of Europe. Some consider the IMF’s decision as an epochal change, while others see it as practically irrelevant. What is the truth?
First, the yuan’s inclusion into the SDR mechanism provides no short-term market opportunity, but it is a significant event. It is a sign of the rise of China, and the West’s recognition of this fact. It reflects also a relative decline of Europe’s economic importance (and Atlantic trade relative to Pacific trade). Europe is tarnished with conflicts (Münchau lists them: refugees, terrorism, Russia's invasion of Ukraine, Eurozone sovereign debt, Britain's future in the EU, Greece's future in the Eurozone, the Portuguese constitutional crisis, Catalonian Independence, Italian banks, Volkswagen), while China, although has its own problems, seems to have a strategic sense of direction.
Second, the change in the yuan’s status will not shake markets, because the SDR is only official money, which serves as a unit of account for the IMF and it is only accepted as a means of payment in official-to-official transactions.
Third, the yuan’s inclusion in the reserve basket will not threaten the dominance of the U.S. dollar. The greenback is still the major reserve currency, which accounts for more than 63 percent of the official reserve holdings, while only a bit more than 1 percent of global reserves are in invested in the yuan (less than some currencies not included in the SDR mechanism). And this situation will not change soon, given the restrictions on capital flows in China and the lack of transparency in the Chinese financial markets.
Fourth, the IMF’s decision will not necessarily undermine the position of the euro. It is true that the euro will see the biggest drop in weighting to make way for the inclusion of the Chinese yuan, but the euro’s future global status will be a market outcome, not the result of the IMF’s decision about the SDR weights. The euro’s actual importance as a reserve currency is much lower than implicated by its SDR weight (while the U.S. dollar’s significance is higher).
Summing up, what does this all mean for the gold market? The yuan’s inclusion in the reserve basket is an important change, but will not significantly affect the global currency market. The divergence of monetary policies will remain the biggest short- and middle-term mover for the currencies, including gold. The Fed is expected to raise interest rates in December and maybe a few more times next year, while both the ECB and the PBOC are conducting monetary policies that are more expansionary. Thus, despite the possible (but very gradual and long-term) rise in demand for the yuan, the U.S. dollar exchange rate is expected to rise, which is not good news for the gold market.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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