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New Drama: Yuan vs US Dollar

In the last two or three days, I received several emails asking for my opinion related to the rumors that the International Monetary Fund (IMF), in the next October, will announce that the currency of China, Yuan or Renminbi (RMB), will be the ‘pair’ for US Dollar (USD) as the world reserve currency. And if the rumors were right, the USD will no longer be dominant in its position as the world’s major currency. There will be dramatic changes where institutions/individuals will immediately convert their USD denominated assets into Yuan, and the value of the USD would be dropped.

Yuan vs Dollar. Source: www.laowaiblog.com

The rumors were raised by Theo F. Toemion, a prominent money trader who had served as the head of the Investment Coordinating Board (Badan Koordinasi Penanaman Moda/BKPM) of Indonesia, between 2001 and 2005. And after I do some googling, the issue of Yuan vs. Dollar is actually one of the most hot issues in the field of money markets worldwide.

But before we discuss the issue, then maybe we need to learn the story from the beginning. Okay, here we go:

Since 1969, the IMF has a special currency called 'special drawing rights' or SDR, which can only be redeemed/converted into four currencies, namely the US Dollar, Euro, British Pound Sterling, and Japanese Yen. Therefore, the value of SDR is determined by the four currencies. At the latest review in 2010, the value of SDR is 41.9% determined by USD, 37.4% by Euro, 11.3% by Pound Sterling, and 9.4% by Yen. By the IMF (and, therefore, by the world), the four currencies are called as the world reserve currencies, with USD at the top of the table.

The IMF holding most of their assets in form of SDR. And central banks in the countries that are members of the IMF, including Bank Indonesia, also can hold some of their assets in the form of SDR. But SDR is not an ordinary currency that can be owned by commercial bank, private institutions, government, or individual, but can only be held by the central bank. When a central bank, let say Bank Indonesia, wants to lend to local banks, they will first convert the SDR into one of the four currencies earlier (usually USD), then convert it further into Rupiah, thus the money is ready to use.

Every five years, the IMF regularly hold a review about which currency that could determine and be directly converted into SDR, or in other words, to be a ‘member’ of world reserve currencies. When SDR was launched for the first time in 1969, there was only one currency that determines the value of the SDR. The currency was USD, where the value of 1 SDR is equivalent to 1 USD. Fifteen years later, ie in 1981, the value of the SDR was determined by five different currencies (not only the USD), namely USD, Deutsche Mark, French Franc, Yen, and Pound Sterling. And in 1999, the 'composition' of SDR has changed once again into USD, Euro, Yen, and Pound Sterling, which is unchanged until today.

And here we come into the interesting part: In its last review in 2010, the IMF has set USD, Euro, Yen, and Pound Sterling as the member of world reserve currencies. But not long after, the chairman of the People’s Bank of China (Chinese Central Bank), Zhou Xiaouchuan, complained that the Chinese currency, Yuan, should also be a member of world reserve currencies, considering China is one of the countries with the largest economies in the world, even bigger than Japan and UK.

So when the IMF will hold another review about the composition of world reserve currencies in next October, rumors arise that Yuan will be announced as the new currency that also determines the value of SDR, thus SDR can be directly converted into Yuan (without having to be converted first into USD, Euro, Pound Sterling, or Yen).

But this does not mean that Yuan would instantly become a ‘rival’ for the USD, actually it is still far from it, because the position as a world reserve currency is not only occupied by the USD, but also by the Euro, Pound Sterling, and Yen. It’s quite clear that Yuan should first ‘beat’ the Yen, Pound Sterling, and also the Euro as the currency that have the most influence on the value of the SDR, before then it could be head to head with the USD.

But, indeed, if Yuan is later announced as the new world reserve currency, then large institutions around the world will begin to convert their USD (or Euro, Pound Sterling, Yen) denominated assets into Yuan. The value of Yuan will rise significantly, while the value of the USD and the other three currencies may be down.

The question, will the IMF actually going to do that? And if it will, then how the impact on the Rupiah, Indonesia's economy, and the Jakarta Composite Index (JCI)? There may be no direct answers. But when Yuan become a new world reserve currency, here are the things that might happen:

  1. The value of USD may be down, including towards the Rupiah, and it would have a negative impact for investors/companies that have assets denominated in USD, but on the contrary, will have a positive impact for investors/companies that have debt denominated in USD.
  2. The 'rise' of Yuan will make the trade transactions between China and Indonesia to be easier, where exporters from Indonesia no longer need to convert the Rupiah into USD (and the importers from China will convert it again into Yuan), but can directly convert it into Yuan, and vice versa. Currently China is still the largest trading partner for Indonesia.
  3. If the value of USD is really down, then the prices of commodities including palm oil and coal, which has always denominated in USD, will probably start to climbing up.
But about the impact on the Indonesian economy and also JCI, then since this event has never happened before (the last time the IMF changed the ‘membership’ of the world reserve currency, it happened in 1999, and at the time the movement of the index was still more influenced by local economic conditions after the monetary crisis), I frankly do not have any idea. Perhaps Mr. Theo is rightly said, that radical changes will occur where some people will suddenly become poor, and some other people will suddenly become rich, but also possible that there is nothing that going to happen. You know, since the year 2011 until today, we have often fulfilled with the story of horrible things that would happen if Greece went bankrupt. But after Greece was actually bankrupt (technically bankrupt, since its people refused to pay the debt to the IMF), there is nothing but a small market correction. The JCI was actually down since the year to date, but it is more because of the bad economic conditions in the country.

On the other hand, the IMF may going to decide that the Yuan will be a member of reserve world currency, but also may not. So maybe we will discuss this matter later, probably after the October. But if you are familiar about the dynamics of the financial markets, you can submit your opinions/analysis related to Yuan through the comments field below.

Any inquiries about investment in Indonesia Stock Market, please send an email to teguh@averepartners.com.

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