With world currencies bouncing back and forth, it can be difficult to decide where to invest, especially with China making moves to make the yuan an International Monetary Fund (IMF) reserve currency and set up a new physical gold price mechanism. Will the dollar fall if the yuan becomes a new reserve currency with the IMF? What happens to gold prices during this process and if the new Chinese price mechanism is set up? Let’s take a look:
Yuan as Potential IMF Reserve Currency
A reserve currency is money held by a country to handle currency exchanges and international purchases. Current IMF reserve currencies include the U.S. dollar, the Euro, the British pound sterling and the Japanese yen. In countries where the reserve currency is issued, imports can be purchased at a lower cost because there are no exchange fees involved. This gives these countries a leg up in trade deals. Because the dollar is considered the primary reserve currency, the U.S. has been able to affect international policy by imposing monetary sanctions against particular countries, making trade more difficult for those countries until they fall in lie with U.S. policy.
The IMF hasn’t added a new reserve currency in 35 years, and China is the second-strongest economy in the world. If the yuan were to become a new IMF reserve currency 1, there would likely be shock waves sent through both international politics and the world’s markets. The dollar would face the possibility of being replaced or rivaled as the dominant world currency, and the U.S. may slip in its position as the dominant world power. Countries may decide to trade in yuan rather than the sliding dollar, thereby positioning China as an even stronger economic world force.
Advantages for the Yuan
In addition to these benefits, China would gain what are called Special Drawing Rights (SDR), allowing them to exchange SDRs for other freely exchanged currencies, with the value of the SDR based on a basket of reserve currencies. The Chinese economy is strongly tied to manufacturing and export sectors. If the yuan becomes a reserve currency, it’s easier for other countries to trade with China without having to exchange into U.S. dollars or other reserve currency and then into the yuan. The purchaser can simply pick up yuan without the U.S. acting as a middleman in the process.
Though China is still talking to the IMF to add the yuan as a reserve currency, several things must happen first. The financial controls China has in place on currency exchange 2 as well as restrictions on international sale of government bonds must be significantly scaled back or removed all together so the free flow of currencies can occur, an issue even its recent ally, Russia, sees as problematic. According to Russian International Bank chair Yevgeny Retyunsky, “It is unlikely that a regulated currency, that is not a freely convertible currency, can be a reserve currency. The Chinese yuan is not a freely convertible currency – there are certain restrictions, such as intervention of the state in the exchange rate policy.”
Gold Price Mechanism
In addition to the push for reserve currency status for the yuan, China announced it will be starting a new gold pricing mechanism only ten days after the country was invited to participate in the London gold fix. It’s planned as a physical gold sales mechanism as compared to U.S. Comex’s paper futures and derivatives. With the Shanghai Gold Exchange’s swift rise to the world’s largest gold fund, it’s poised to take over gold pricing and gold price discovery, currently quoting prices as high as $600 over paper gold spot prices.
But what does that mean to an investor? Whether the dollar topples or the yuan becomes a reserve currency, gold ties the markets together. When the U.S. dollar slips due to a strong yuan, gold will be rising. Whenever the dollar falls, gold is a strong investment to have, as it always holds value, despite turbulent economic policy changes across the world. Physical gold is an asset that outlasts temporary economic woes, and will be a smart investment to have on hand as the dollar faces decline.
Additional Sources:
1 – https://orders.cloudsna.com/chain?cid=MKT035907&eid=MKT042022&snaid=&step=start
2- http://english.pravda.ru/business/finance/07-04-2015/130211-yuan_reserve_currency-0/