On Saturday China quietly joined a select group, one it had sought entrance to for decades, when the yuan officially became one of the world’s reserve currencies by the IMF. This marks the first new reserve currency since the euro was added in 1999. It’s unclear whether the decision was timed to coincide with the anniversary of the Communist Party’s founding of the People’s Republic of China in 1949, but if you believe in omens it’s certainly disquieting.
Critics argue the yuan hasn’t earned reserve currency status based on the IMF’s own criteria, and see the move more as a means of prodding Chinese authorities to open up their financial markets to outside scrutiny. But while China’s made some efforts toward letting the People’s Bank set interest rates without government interference, and to lift capital controls that are in direct opposition to the IMF’s stated standards, they still operate notoriously closed financial markets.
The politics of labeling China a currency manipulator indeed makes some strange bedfellows. Donald Trump has vowed to formally call out China for its tactics if he wins the election. That position aligns the Republican candidate with Democratic New York Senator Chuck Schumer, who sees the current IMF strategy as rewarding China for being a currency cheater. Including the yuan in the IMF’s basket of reserve currencies legitimizes it as a secure store of wealth, one that’s safe for companies worldwide to do business in. So despite China’s destructive—and recent—history of arbitrarily devaluing the yuan, currency traders expect now, with this IMF stamp of approval, the trading volume of yuan, also known as the renminbi (RMB), or “people’s money,” will increase in world financial markets.
Seated at the Big Kids’ Table
Adding the yuan to the world’s reserve currencies presents an unusual dilemma for world markets. A couple decades ago, China’s strategy of keeping its currency artificially low was a way to lift its billions out of poverty through becoming the world’s manufacturing center. Companies that sought to maximize profits shuttered plants here and headed to cheaper pastures.
But now China’s come up in the world the nation sees its currency as a way of extending its global financial influence. The more people who hold the yuan in their bank accounts, the more people have an interest in China’s economic prosperity. That’s why China has been willing to make some token efforts at opening up its markets, though this new openness came with unintended consequences.
The Devaluation Spins Out of Control
In the year since the IMF announced the impending inclusion of the yuan as a reserve currency, the devaluation of the yuan has continued. But this time it’s not China trying to push its currency value down; it’s the result of rest of the world pulling capital out of Chinese markets. Normally, a nation’s currency rises when foreign capital flows into its markets. That’s how the U.S. has been able to afford to carry such a large load of debt, and why the dollar has almost been too strong in the last five years. But after the crash of their stock market earlier this year, China faces the opposite problem, with foreign investors pulling cash out of their markets. The outflow was so bad that China had to put limits on foreign currency withdrawals, meanwhile the yuan is still trading at six-year lows.
The Irony, it Burns
Despite the government limits on withdrawals, foreign reserves at the People’s Bank reached dangerously low levels, continuing to put downward pressure on the yuan. After being a shameless lowballer for decades, China’s now in the awkward position of trying to artificially boost the value of the yuan, with many analysts agreeing it’s still overvalued. Oh, the irony!
With their markets still sluggish, adding that same unstable yuan to the world’s reserve currencies means China’s economic weakness will spread along with its currency, slowing growth for the rest of the world. That seems like a high price for the rest of the world to pay.