1. Nous Sommes Paris: The attack in Paris is tragic and reprehensible. Our thoughts and prayers are with the victims and the people in France. There are several political and economic consequences, aside from the tighter security and elevated alertness. The attack overshadowed other issues at the G20 meeting. On one hand facing terror, investors often reduce risk. At the same time, officials often provide reassurances that they have the will and means to address any liquidity needs.
The attack on France may have serious repercussions on the immigration/refugee debate that has already unleashed centrifugal forces pulling Europe apart as much if not more than the creditor/debtor dispute that focused on Greece earlier this year. In terms of more parochial political issues, it may serve as an opportunity for a political reset for French President Hollande, whose support has been undermined by the poor economic performance. In Germany, Merkel has taken a bold and controversial stance, and her critics are likely to use the Paris attack to press their case.
2. SDR: After the markets had closed for the week, IMF’s Lagarde announced that the staff has concluded that China meets the requirements to join the Special Drawing Right. Not only do they judge the yuan to be “freely usable”, but also that China has “addressed all remaining operational issues identified in an initial staff analysis submitted to the Executive Board in July.” In recent days, some observers feared that nine consecutive higher dollar-yuan fixes and some re-widening of the spread between the onshore and offshore yuan (CNY and CNH) would jeopardize China’s ascension. US and European officials have indicated that provided that China meets the IMF criteria, which the staff says it does, they will not block it.
Assuming that this is the case, there are two immediate issues. First, currencies in the SDR are assigned a weight. What will be the yuan’s weight? Many observers who have addressed this issue anticipate that the yuan’s initial weight is something more than the yen’s 9.4% share and around sterling’s 11.3% weight. The risk seems to be on the downside. The weighting is determined the size of a country’s exports and the use as a reserve asset. The first consideration would appear to give China a high share given that it is the world’s largest exporter. However, an important caveat is that Hong Kong, a part of China it refers to as a Special Administrative Region, takes in around 15% of China’s exports, which are not really exports under the traditional definition. As a reserve asset, China’s share is well below even the Canadian and Australian dollars, let alone the yen and sterling. The IMF estimates that it is around 1%.
The second issue involves the reaction by investors and reserve managers. Recall new SDR basket will not be launched until September 2016. The yen’s inclusion in the SDR has not made the Japanese currency a major reserve currency or an important international currency. Foreign investors tend to hold a low share of Japanese equities, and their Japanese government bond holdings are well below benchmark indices. Inclusion in the SDR is not the necessary and sufficient condition to attract asset and reserve managers. The continued opening up of China’s financial markets and greater transparency are the keys. We argue that the real value of joining the SDR lies in the acknowledgment that China is one of the great financial powers.
