Any exporting nation should be happy with a weak currency. For starters, it should increase the demand for manufactured goods that are in the country and on top of that it should increase the domestic demand for a country’s industrial output as it will become more interesting than importing a lot of the goods.
A simple example might be helpful here. When the Dollar is cheap and the Euro expensive, would airline carriers place an order with Boeing or Airbus? The answer is pretty straightforward, as everyone with a common sense about how economics work would say that Boeing would get the order due to a cheap dollar, reducing the expense in the third currency compared to buying an Airbus in Euro.
So, the Euro went down the drain lately and has lost approximately 25% of its value compared to the US Dollar in less than a year time. That’s obviously excellent for the exporting countries in the Eurozone, but then the question arises why on earth the US government (or the Fed, for that matter) allows the US Dollar to appreciate this fast? It would only need a few comments from Fed chair Yellen saying the Fed will not raise its interest rate this year to make that happen.
So, why didn’t she do so? Why does the USA seem to be happy with its expensive currency which is slowly suffocating the export-focused sectors of its domestic industry? There might be another factor at play here, a factor everybody has chosen to ignore.
The IMF system is based on Special Drawing Rights, or ‘SDR’s’ in short which is considered to be an IMF reserve asset. The IMF itself defines an SDR as a ‘potential claim on the freely usable currency reserves of member countries’. The SDR’s were originally based on the value of gold, but this was later converted to a basket of the Euro, Japanese Yen, the US Dollar and the British Pound which were considered to be the main reserve currencies of the world.
Fast forward to 2015. What might these SDR’s have to do with the wish of the USA to have a strong Dollar instead of a weak dollar? Just a few weeks ago, China has hinted to the IMF it would like to see the Chinese Yuan being included in the basket of foreign currencies. This isn’t an unrealistic claim as China has become one of the world’s economic powerhouses. It’s extremely important to note the next IMF meeting to discuss the basket of currencies included in the SDR system is scheduled for the end of this year (the previous meeting was in 2011, so China doesn’t get a lot of chances to be included).
This might have worked as a red flag for the USA. The addition of a fifth large currency could effectively undermine the credibility of the US Dollar as it would see its importance in the SDR system being reduced. This could (and very likely will) lead to the fact all foreign central banks would dump a part of their Dollars to buy the Chinese currency and this flood of US Dollars couldn’t just reduce the purchasing power of the Americans, it would also mean the complete end of an era of cheap borrowing costs. As a large part of the total amount of outstanding US Dollars isn’t ‘in circulation’ but just held by central banks, the borrowing costs for the US government are much lower exactly because the amount of USD in circulation.
It’s not easy to try to calculate the impact, but professor Kenneth Rogoff of Harvard University estimates the status of the US Dollar as world reserve currency saves the public and private sector approximately $100B per year. If the foreign central banks (which have approximately 60% of their assets in US Dollars) would drop the ratio of USD vs total reserves to 50%, the total additional bill for the country could be close to $20B per year. If the ratio would get diluted to 40%, the difference might be as high as $55-60B per year. This means that more than half a trillion of wealth will be evaporated by 2025, and as much $2.2 TRILLION could disappear by 2050.
Source: JP Morgan
Needless to say it’s in the very best interest of the USA to avoid a fifth currency (or gold) to be part of the IMF ’s SDR system. But another question and part of the equation is whether or not China would even be interested to get its currency in the SDR basket?
The answer is yes. Back in March of this year, China’s prime minister has made an official request to the International Monetary Fund to ask the fund to include the Chinese Yuan as fifth currency in the basket. The timing of this request is impeccable because the basket is up for revision by the end of this year and the Chinese now have several months to convince the IMF they are willing to take all measures to ensure a better and more transparent trading system for its currency. The IMF is definitely open for the idea as Lagarde, the head of the IMF, has confirmed ‘the Yuan will be part of the SDR basket at some time in the future’.
So the recent strength of the US Dollar could be yet another trick of the Federal Reserve and the US Government to emphasize the need of a strong US Dollar as part of the official IMF basket of currencies. This working theory could make a lot of sense given the fact the United States just cannot afford it to see its status as main reserve currency slide.
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