Vice Premier Li Keqiang of China (R) meets International Monetary Fund (IMF), Managing Director Christine Lagarde (L) inside the Great Hall of the People in Beijing on March 23, 2015 in Beijing, Кытай. (Lintao Zhang/Getty Images)Vice Premier Li Keqiang of China (R) meets International Monetary Fund (IMF), Managing Director Christine Lagarde (L) inside the Great Hall of the People in Beijing on March 23, 2015 in Beijing, Кытай. (Lintao Zhang/Getty Images)

They promised, they delivered. The World Bank will issue a $2.8 billion SDR bond, or Special Drawing Rights bond, in China in August. Separately, the China Development Bank will also issue between $300 million to $800 million of SDR notes.

Кытай, the International Monetary Fund (IMF), and interested think tanks have been pushing the idea of private SDR since the beginning of the year. It has now come to fruition. But what does it actually mean?

Initially, SDR-denominated bonds will be of particular interest to official investors, but gradually, they will also attract investors from private sectors.

— Zhu Jun, director general, PBOC

The so-called SDR is an IMF construct of real currencies, right now the euro, yen, dollar, and pound, without actually containing any of them. It is just a claim to demand payment in these currencies. It made news last year when the Chinese renminbi was also admitted, although it won’t formally be part of the basket until Oct. 1 of this year. The IMF and member countries trade the units currently worth $1.40 among each other.

“Initially, SDR-denominated bonds will be of particular interest to official investors, but gradually, they will also attract investors from private sectors. In such a way an SDR bond market will be developed,” Zhu Jun, the director general of the People’s Bank of China’s (PBOC) international department told Chinese business paper Caixin.

Worth Wray, the chief global macro strategist of STA Wealth Management agrees: “Right now there is no organic demand, but over a five-year horizon it could develop globally and maybe that creates another channel for capital to flow into China—if that’s the only market there is for it,” he said in an interview.

The SDR bonds issued by the two official institutions are different from the official SDR issued by the IMF. In fact, they are a derivative of it. When the World Bank unit called International Bank for Reconstruction and Development (IBRD) issues the bonds, it receives payment in yuan from the Chinese market or at first from the issue’s underwriter, the Industrial and Commercial Bank of China.

It can then proceed to spend the yuan either in China or exchange them for other currencies and spend them abroad. So far the IBRD has disbursed $46 billion worth of loans, grants, and credits in China. It is important to note that this process is effectively creating SDR, which have previously not existed.

Chinese investors receive the SDR bonds, but what do they actually own?

For the Chinese investors, there is the advantage that they can hold a sizeable non-yuan denominated asset in China and reduce their risk to the Chinese currency.

Official SDRs can be redeemed for dollars, euros, yen, pound, and soon yuan through the IMF. Бирок,, the new private SDR, or M-SDR as the IMF calls them, cannot. The new bonds represent a claim on the IBRD. Since the IBRD doesn’t have any SDR assets, the repayment will also be in yuan, dollar, euro, yen, or pounds. So what’s the point of having this new basket?

For the IBRD, there is no advantage because it is borrowing in strong currencies and getting paid in a relatively weak one. For the Chinese investors, there is the advantage that they can hold a sizeable non-yuan denominated asset in China and reduce their risk to the Chinese currency, which may further fall in value. Because of still existing capital controls, buying foreign assets in size is not yet possible on the Chinese domestic bond market.

Бирок,, this is only an advantage for the time being. At the point of maturity, foreign currency will have to flow from the IBRD to the Chinese bond holders, unless they choose repayment in yuan, in which case the whole exercise would be rather pointless.

So given this lackluster value proposition, why are China, the IMF, and the U.S. controlled World Bank going out of their way to push the SDR into private markets?

Prominent market observers like James Rickards and Willem Middelkoop have long argued that the SDR will be the next world reserve currency. In fact, the current governor of the PBOC Zhou Xiaochuan has advocated for the SDR to become the next global reserve currency for a long time now.

“Special consideration should be given to giving the SDR a greater role. The SDR has the features and potential to act as a super-sovereign reserve currency,” wrote Zhou in 2009. He also wanted the yuan to be included in the SDR, which is going to happen on Oct. 1. Take heed of his predictions.

It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs.

— James Rickards

“The Chinese … have made it very clear that the Special Drawing Rights of the IMF is the preferred future international world reserve currency,” writes Willem Middelkoop in a note to clients.

“What you are going to see is world money. You are going to see the IMF print Special Drawing Rights (SDR). It’s a geeky name but it’s a kind of world money printed by the IMF. They’ll flood the world with trillions of SDRs, James Rickards told Epoch Times earlier this year.

Now that the first issuance is well underway, it is easy to lever up the balance sheets of international development organizations and keep issuing—or printing—SDR obligations even in the trillions until even private market actors support and accept them. Once the SDR is widely accepted as payment, the IMF could just redeem all outstanding local currencies for SDR and the world would not only have a new reserve currency, but just one global currency.

“You create new liquidity. That’s the kind of reform that could change the international system immediately,” says Worth Wray.

Willem Middelkoop says this could be done through an IMF substitution fund, an idea already discussed in the 1970s. “This fund could facilitate a direct exchange of dollars for SDRs. The liquidity issue would be resolved with one stroke of the pen, as an SDR would be created for every dollar that was exchanged,” he writes in his note.

Sounds crazy? It is, but the official plan is right here, for everyone to see.

Twitter: @vxschmid

Толук макаланы окуп

The cat is out of the bag. China will join the club of nations whose currencies make up the international reserve basket.
The basket is called Special Drawing Rights (SDR) and the International Monetary Fund reviews its contents every five years, including 2015.
Tipped for an inclusion this year, China’s yuan has finally gotten the nod.
“The renminbi meets the requirements to be a ‘freely usablecurrency and, accordingly, the staff proposes that the executive boardinclude it in the SDR basket as a fifth currency,” IMF Managing Director Christine Lagarde stated on Nov. 13.
MORE:Experts on IMF Accepting China Into Reserve Currency Basket [PODCAST]
The final decision by the IMF executive board on Nov. 30 will be a mere formality.
And yet, nobody is getting excited about the move previously lauded as landmark progress.
“The SDR has not relevance to everyday markets,” says Fraser Howie, author of “Red Capitalism.
The problem with the SDR is that is actually does not contain anything. It is merely the valuation of a basket of currencies with different weightings (dollar, euro, sterling, yen, renminbi) and only exists as a unit of account, used by the IMF.
If a an IMF member country needs one of those or all currencies he can sell his SDRs and get the cash. But before that, it’s all smoke and mirrors.
“In normal circumstances there is no boost in demand for a currency simply because it is in the SDR basket,” writes Mark Williams of Capital Economics.
Prestige
So what are the benefits for China. It’s mostly a matter of prestige.
“One answer is simply that it could. There is no downside, there was little resistance since it is an issue that few in the international community care about, and there is a modicum of prestige in being asked to join a small club, even if few were aware of its existence before,” writes Williams.
The global economic picture may also have influenced the IMF decision, according to Diana Choyleva, chief economist at Lombard Street Research.
“If the yuan is included it is still likely we will see yuan depreciation, but it will be more gradual with heavy intervention from the authorities to make it more gradual,” she says.
China would devalue heavily and swiftly if not included she thinks, shocking the world economy.
Despite the relative insignificance of the event, Fraser Howie believes the IMF should have tracked China for longer before giving it the nod.
“You don’t simply have a free trading currency just because you say so. I as the IMF would like to see a lengthy period of time where you can see these reforms in practice. How is China going to respond in times of crisis,” he asks, referring to the gross mismanagement of the stock market crash this summer.
China severely hindered market forces rather than letting them play out and Howie thinks they could do the same once the currency becomes freely tradable. China has indicated it would like to have complete convertability by 2020.
“After the stock market bubble burst they just continue to clamp down on markets, pull away rights to trade, create an environment where people are afraid to trade even though they have done nothing wrong,” says Howie.
In fact, the IMF has reserved itself a little wiggle room. Instead of accepting the currency as of Jan. 1, 2016, as it is customary, it will wait until September of 2016, despite a positive decision this November.

Толук макаланы окуп