Chinese Yuan Could Give the IMF "a Shock It Isn't Prepared For"

On Monday, the Chinese yuan joined one of the most elite clubs on the planet: the International Monetary Fund's Special Drawing Rights basket of reserve currencies.

Scheduled to take effect next October, the yuan will be weighted at 10.92% - greater than fellow basket members the Japanese yen and the British pound, but less than the euro and the U.S. dollar.

CURRENCY OLD WEIGHT NEW WEIGHT
U.S. Dollar 41.90% 41.73%
Euro 37.40% 30.93%
Chinese Yuan - 10.92%
Japanese Yen 9.40% 8.33%
Pound Sterling 11.30% 8.09%

*Source: IMF

Earlier this year on Aug. 4, the IMF said China would have to move ahead with market liberalization before it would allow the yuan in. The currency's inclusion this week shows the organization is happy with China's progress. IMF Managing Director Christine Lagarde said the yuan's inclusion was based on "a clear indication of the reforms" China has carried out.

What It Means to Be a Global Reserve Currency

Reserve currencies are held in significant amounts by governments and institutions around the world in order to help conduct transactions in the global market.

Designation as a global reserve currency sends a message about a currency’s economic heft to the rest of the world. To be in this VIP club, a currency must be “widely used,” “widely traded,” and “freely usable,” according to the IMF.

"The continuation and deepening of these efforts will bring about a more robust international monetary and financial system, which in turn will support the growth and stability of China and the global economy," Lagarde said in Monday's statement.

Of course, the IMF could be dead wrong.

"From a practical position, the IMF expects China will have to make its currency more 'freely tradable' than it is - which, along with being a 'major exporter,' is the other criteria the IMF considers in conferring reserve status on a currency," Money Morning Capital Wave Strategist Shah Gilani said on Monday. "But there's a possibility the IMF jumped the gun on this."

Dark horizons lay ahead if the Chinese yuan isn't stable enough to deserve its new global reserve status...

The Chinese Yuan Is a Dangerous Wild Card

burning-chinese-yuan"If China lets the yuan adjust to other major currencies by purely market forces, which none of the other reserve currency countries - the U.S., Great Britain, the European Monetary Union, and Japan do - the IMF may get a shock it's not prepared for. And I mean a major shock," Gilani said.

We all saw what happened in August. People's Daily, the Communist party's mouthpiece, declared Aug. 24 "Black Monday." The Shanghai Composite closed down 8.5% that day - the benchmark index's worst single-day fall in eight years.

The pain radiated outward from there.

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The Nikkei index in Japan slipped 4.6% to its lowest level since February. The UK's FTSE dropped 4.7% in its worst one-day performance since 2009. The Stoxx Europe 600 closed more than 5.3%, while Germany's DAX was down 4.7%. And the Dow Jones fell more than 1,000 points in the opening minutes of trading.

China's crash extended beyond stocks, too - emerging-market currencies tumbled; oil hit a six-and-a-half-year low.

The proximate cause for all of it was the country's surprise devaluation of the yuan on Aug. 11. By month's end, more than $5 trillion had been wiped off global stock prices.

"If China's economic miracle goes through a meltdown, the Chinese yuan will collapse on the open market. The IMF, with not only egg on its face but also a global banking crisis to deal with, will prove it's nothing but a relic of a bygone era of U.S. hegemony in the free world's political and economic past."

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