Opinion: Dollar’s status won’t be tarnished by sale of Chinese SDR bonds
By David Marsh
Published: Aug 22, 2016 11:37 a.m. ET
Yuan-linked bonds is a step toward more acceptance, but U.S. dollar is still king
The World Bank’s forthcoming launch of $2.8 billion worth of bonds denominated in special drawing rights on the Chinese market is a further landmark step in China’s long march to support the International Monetary Fund’s composite accounting unit as a potential rival to the dollar.
The World Bank’s issuance of SDR bonds, payable in yuan USDCNY, -0.0782% , is expected to be followed by further similar issues for the China Development Bank and other Chinese banks.
The relaunching of SDR-denominated bonds after a three decades’ absence is linked to the yuan’s entry into the SDR on Oct. 1 , where it joins the dollar DXY, -0.04% , euro EURUSD, +0.1148% , yen USDJPY, -0.05% and sterling GBPUSD, +0.0076% as an acknowledged reserve currency.
This could open the way for central banks and other official institutions to boost SDR- and yuan-denominated investments.
Subscription in yuan for the SDR bonds is part of an effort by the Chinese authorities, prefigured in talks with the IMF some months ago to allow domestic Chinese investors to participate in bond issues with a significant foreign-currency component.
This will help not only to boost development of the Chinese bond market but also to damp capital outflows that have gained ground in the last 18 months as a result of progressive liberalization of capital controls.
Chinese foreign-exchange reserves have steadied around $3.2 trillion since February after earlier falling sharply from $4 trillion in mid-2014. This stabilization has matched general developments among emerging-market economies, where foreign-exchange reserves have starting to rise again after an 18-month slide.
In a research paper in July, the IMF pointed to Chinese investors’ untapped demand for exposure to reserve currencies. “From this perspective, M-SDRs [market-based SDRs] issued in the onshore market could potentially reduce demand for foreign currency and reduce capital outflows by allowing domestic market participants to diversify their foreign-exchange risk.”
The People’s Bank of China has imbued the move with unusual significance. It stated on its website that the reopening of the SDR market will “enhance the stability and resilience of the international monetary system [since] bonds denominated in the SDR will provide a hedge against the interest rate and exchange rate risks stemming from financial instruments denominated in a single currency.”
However, no one should believe that a combination of Chinese and IMF initiatives adds up to a major impending threat to the dollar.
History is littered with episodes — the most spectacular was the planned IMF SDR “substitution account” in 1979-80, which led to a major dollar revival — where projects aimed at dismantling the dollar’s primary role ended up strengthening it.
Disruptive geopolitical occurrences (and the election of Donald Trump might be one) tend to underpin rather than undermine the dollar’s status.
As Paul Tucker, former deputy governor of the Bank of England, pointed out earlier this year, the dollar’s celebrated “exorbitant privilege” extends beyond “geopolitical returns and reduced funding costs” since it also provides “an economic shock absorber and, therefore, domestic political insurance.”
Applied to the Chinese case, if the yuan were ever to become a full-fledged world currency backed by deep, extensive and reliable Chinese financial markets, any upsurge in geopolitical tensions in Asia, for example over Chinese territorial claims, could spark a rise in the yuan — a welcome “geopolitical hedge” for the Chinese leadership.
Equally, however, accomplishing this longer-term role faces grave setbacks if fragility emerges in China’s political and economic system, for example over the Chinese growth slowdown accompanied by capital-control liberalization and increased foreign influence on the Chinese economy.
These factors explain why emulating the dollar is high on the agenda of top Chinese government officials — and simultaneously why they know that achieving this aim is extraordinarily difficult.