China joins the reserve currency clubWhat it means for gold.
Saturday, October 1, marks a significant milestone in the world of global finance as the Chinese renminbi enters the basket of world reserve currencies, joining the U.S. dollar, euro, Japanese yen and British pound.
The decision by the International Monetary Fund to give the renminbi special drawing rights status (which was actually announced by the IMF last November) caps a multi-year effort by the Chinese government to gain entry into the exclusive club of global financial heavyweights.
Despite fears of the renminbi usurping the U.S. dollars dominant role in global markets, the greenback will retain its place as the worlds reserve currency of choice for some time to come. But gold investors should pay attention to the rise of the renminbi, as the Chinese economy continues to grow and gain influence on the global financial stage.
A symbolic move
The inclusion of the renminbi in the IMFs reserve currency basket is a de facto stamp of approval, denoting Chinas currency as a widely accepted and liquid form of exchange.
Chinas currency plays a small but growing role in global finance. With its special drawing rights status, more global central banks will add renminbi to its reserves. More business transactions will also be conducted in the currency, more than the 2% of trade that is done in renminbi as of 2014.
The ascension of the renminbi alongside the U.S. currency may seem a threat to the dollars long-time supremacy in global markets. It does change the game in many respects, but the dollars importance on the world financial stage isnt about to fade.
For one, the U.S. dollar will remain the dominant currency in the IMFs special drawing rights basket, at 41.7%, even after the renminbi is added to the mix. In fact, its the other reserve currencies (the euro, yen and British pound) that will lose share to make room for Chinas currency.
A matter of trust
Second, trust matters more than the IMFs tacit approval among financiers looking to do business in China. Financial reform in the country has come a long way, but the Chinese government needs to do more to increase transparency and build the regulatory infrastructure that can increase trust among the investment community.
The U.S. dollar wont lose its title as the worlds reserve currency anytime soon. That means commodities from oil and natural gas to precious metals like gold and silver will continue to be priced in dollars. Plus, fluctuations in the value of the U.S. dollar will continue to influence the price of gold and silver.
Thats not to say the dollars premier status is ironclad. The U.S. currencys leading position is under threat more from internal pressures: a large overhang of government debt that continues to grow and widening trade imbalances could loosen the foundation that has made the dollar the standard denomination for pricing hard assets.
Hedging reserve currency risks
But the challenge to the dollars dominance as the worlds reserve currency will be played out over the long term. A collapse in the dollar is an outlying possibility, but its a risk that gold can help hedge. Gold can act as a form of insurance to help preserve wealth should dollar-based assets plummet in value.
Gold is also an effective tool for portfolio diversification. Equity and bond investments will be affected by fluctuations in the value of the U.S. dollar. An allocation to gold in a portfolio can help lessen some of the risks investors face from higher volatility in the currency markets.
Greater acceptance of the renminbi will also bring more attention to changes in its value and flows in and out of the country. Any possible devaluation in the currency has the potential to upset global markets, much like what had occurred in August 2015. Those events would also increase investor demand for gold and help push gold prices higher.