There has been, is, and I suppose will continue to be, a near manic cry for investment defense against American fiscal policy. The source of the tribulation this time is the autumn 2016 meeting of the International Monetary Fund.
We expect that the meeting will consider the inclusion of the Chinese currency, the RMB, in the official basket of currencies making up the IMF currency the Special Drawing Right. (SDR) The hype contends that such an inclusion will cause the demise of the US Dollar with attendant darkness and tribulation descending upon the unprepared.
Does the conclusion make sense?
First, I believe anything is possible and that destructive things begun by governments and their agencies are more likely than normal, but I intend to ignore this one.
An SDR is a paper currency used to facilitate transactions between governments. It aims to allow countries to maintain a predictable exchange rate. I recall in the beginning, 1969, they were known as paper gold. The IMF needed gold to support the Bretton Woods currency agreement but there was too little. They noticed that while they were short of gold, they had a nice pile of nothing. They cut the pile of nothing into pieces and made them worth .88 grams of gold on condition that they are not convertible into gold.
That device ceased being useful by 1973 and has since been replaced with a basket of currencies of which the US Dollar is dominant. It is still a non-convertible unit of nothing.
SDRs have been allocated to various countries since 1969 and the total implied value outstanding is about US$ 318 billion. For perspective, that is about 0.4% of the global GDP. Less than a quarter of the amount of US currency in circulation. A month’s spending by the US federal government. If the RMB became 20 percent of the basket and the other currencies reduced proportionally, would it matter?
Any allocation, and for several reasons there is no guarantee that the RMB will be included, will have a negligible effect. Maybe a long term trend will develop but it will take decades to displace the US$.
On the other side, suppose the hype is right and the US$ falls precipitously and the RMB rises to Purchasing Power Parity. That increases RMB relative value 69%. A price increase of that magnitude would, guaranteed, destroy the Chinese economy. All exporters prefer to have their currency undervalued and China is the exporter par excellence today. They are trying to minimize RMB’s value now and have been for months.
They would could sell their US$ bonds. I suppose, but they have about $1.3 trillion and the valuation hit would exceed $500 billion when converted back to RMB.
Bottom line, they are not likely to commit economic suicide, but some gullible folks are going to bid up the price of gold.
While many people want to sell gold to the gullible, this may be a time to step back and think it through. The IMF may very well include the RMB and in prospect of that, you as an investor will need to answer the “best” question.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.