NEW YORK – A decision last week by the International Monetary Fund to accept reserve-currency status for China’s yuan advances a developing plan backed by the United Nations to replace the dollar as the world’s reserve currency.

Last Friday, IMF Managing Director Christine Lagarde endorsed a staff recommendation to include China’s yuan in the basket of four currencies that currently make up the IMF Special Drawing Rights, or SDRs: the U.S. dollar, the euro, the British pound and the Japanese yen. The SDRs play the role of an alternative to the use of the U.S. dollar to settle transactions in international trade.

In a reversal of policy from policy of previous presidents, President Obama has indicated the United States plans to drop opposition to the inclusion of the Chinese yuan in the IMF basket of currencies, giving a green light to anticipated IMF approval of the plan at a meeting of the IMF board Nov. 30.

In 2013, the Society for Worldwide Interbank Financial Telecommunication, a provider of international payments services, announced the Chinese yuan had advanced to overtake the euro to become the second-most used currency in global trade finance after the dollar.

A meeting between U.S. Treasury Secretary Jack Lew with Chinese Vice Premier Wang Yang and Finance Minister Lou Jiwei at the G-20 leaders summit in Antalya, Turkey, provided an opportunity for the Obama administration to make clear to China that the U.S. intends to support the inclusion of the yuan in the SDRs, provided the currency meets the IMF’s existing criteria.

Reuters noted the irony of the IMF decision following the unexpected devaluation of the yuan in August. The move by the Chinese government triggered a global stock market selloff amid objections by World Trade Organization free-trade advocates that it created an unfair price advantage for China’s exports while raising questions about Beijing’s commitments to financial reforms.

Advantages of a reserve currency

William T. Wilson, Ph.D., a senior research fellow at the Heritage Foundation, in a research report published Aug. 17 titled “Washington, China, and the Rise of the Renmimbi: Are the Dollar’s Days as the Global Reserve Currency Numbered?” argues the fall of the dollar has been accelerated by the relatively slow growth of the U.S. economy since 2009 and the accumulation of a sovereign debt set to double in the eight years Obama is in office.

Among the advantages of being a reserve currency, Wilson notes “the reserve-currency countries have the ability to run up fiscal debts denominated in their own currency at relatively low interest rates.”

Wilson lists as additional advantages the convenience for the exporters and importers of dealing in the country’s own currency rather than in foreign currencies, reducing the transaction costs as well as the foreign exchange reserves.

Bob McTeer, a former president of the Dallas Federal Reserve Bank, noted in a 2013 article published by Forbes that being the world’s reserve currency of choice for the past 70 years has boosted the U.S. standard of living “by others’ willingness to hold our currency without ‘cashing it in’ for goods and services, or, before 1971, gold.”

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What are IMF Special Drawing Rights?

When the Bretton Woods fixed-rate system collapsed in August 1973 as then-President Nixon announced what was supposed to be a “temporary” suspension of the U.S. dollar’s convertibility into gold, major world currencies, including the dollar, shifted to a floating exchange-rate system in which the price of the dollar and other major world currencies was set by trading on international currency exchanges.

“The international supply of two key reserve assets – gold and the U.S. dollar – proved inadequate for supporting the expansion of world trade and financial development that was taking place,” explains the IMF “Factsheet” on SDRs.

It describes how SDRs created in 1969 were adapted to become a currency trading facility available to play a role in international trade.

“Therefore, the international community decided to create a new international reserve asset under the auspices of the IMF, ” the IMF Factsheet continued.

Today, SDRs issued by the IMF are used typically by IMF member nations primarily as a reserve account to support international trade transactions, not as international currency available to settle international debt transactions in danger of default.

In an important step, the G20 summit meeting in London April 2, 2009, crossed a threshold toward the creation of a global currency through a proposal calling for the IMF to use SDRs to replace the dollar as the world’s reserve currency of choice.

Point 19 of the final communiqué from the 2009 G20 summit in London specified: “We have agreed to support a general SDR which will inject $250 billion into the world economy and increase global liquidity.” It was the first step toward implementing China’s proposal that Special Drawing Rights at the International Monetary Fund should be created as a foreign exchange currency to replace the dollar.

The Chinese currency is referred to interchangeably as the renminbi, RMB, or the yuan. The currency is officially called the renminbi, while yuan is the unit of account.

The Renminbi, which means “the people’s currency” in Mandarin, was first issued in December 1948 with the establishment of the People’s Bank of China.

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