Risen Dragon: China's Magnified Economic Influence

Disclosure: This post may contain links, which I may receive compensation at no additional cost to you. Read my disclosure for more information.
Photo Credit: Economist

The emerging market train from the 1990s has turned into a worldwide super power.  Just recently, China took a bold step to establish itself as an economic superpower by purchasing $50 billion in IMF bonds.  The move will help China further establish itself in economic trade, as well as produce new outlets for its exports, commodities, securities and business environments.

How IMF Bonds Work

The International Monetary Fund works like a global exchange of currencies for world governments.  Each member pays dues, which are essentially loan representative of its significance in foreign trade, as well as the presence of its currency in international affairs.  However, outside of the normal funding circumstances, the IMF has reached out to the wealthiest nations of the world to raise an additional $500 billion that would stand to fund impoverished and emerging countries in a measure to expand the power of business in bringing economic prosperity.

The Special Drawing Right

The Special Drawing Right is what makes the IMF liquid to member countries.  The conversion rate for each currency to SDR is set by the IMF, based upon the makeup of currencies in the fund.  A parallel could be made in exchange-traded funds, wherein investors trade cash for a basket of stocks.

Unlike Any Other Chinese Investment

The talk spreading throughout the globe suggests China is trying to diversify itself away from US Dollars, buying hard assets in the process.  Interestingly enough, China opted to pay for the IMF bonds with the local currency, the Chinese Yuan, in an effort to increase the number of Yuans available to IMF members for trade.

The Chinese move was interesting because the IMF does not swap currencies or other currencies; instead, nations can opt to borrow money from the IMF in currencies already present in the IMF fund.  Because the Yuan is not freely traded, but tied to a basket of currencies, the Chinese can better establish themselves in foreign trade by adding Yuan to IMF storage.  In this bold move, China is anteing up, hoping that countries will choose to use the Yuan as a reserve currency.

The IMF is a Chinese Exporting Tool

Consider the International Monetary Fund as a chamber of commerce.  Member nations decide to help out others with loans and investments – all while having a near equal interest in the success of each member.  The success of one country can only help its trade partners and neighbors in generating a healthy trade for a sound economy.

In this case, the IMF is a perfect outlet for the Chinese to expand their relatively insignificant standing in the IMF and increase their partnership abilities in global trade.  Each country that borrows from the fund can opt to get the loan in Yuan, which for all intents and purposes, is redeemable only in China.  Consider the Yuan like a gift card to the local coffee shop; you can't use it at the hardware store.

A More Vocal China

Prior to last year, China was one of the more quiet members of the IMF.  Its influence on international trade as defined by the IMF board is small – much smaller than the proportion of power that it vested in China's hands through votes on economic policy and the inner workings of the fund.

Recently, however, China has taken the discussion elsewhere, stimulating a debate on whether the SDR should be used as the world's reserve currency.  The debate has become lively, with many nations and international powers, such as the UN, approving of a world currency.  Of course, many countries, such as the United States, are against this concept.

To China, utilizing the SDR as a world currency could give it more power, as well as an increased ability to sell its Dollar holdings.  The United States, on the other hand, makes up a large, but slowly ebbing portion of the SDR.  Therefore, its safety as the world's reserve currency would only last as long as member states agree to keep such a large vested interest in the Dollar.

China Can Go Nowhere But Up

At this point in time, there is simply no direction that the Chinese economy can move but upwards.  The country's healthy economy and sound currency have won it many trading partners, but its influence in international trade at the bureaucratic level is still well below what is proportional.  As more global economic policy discussions make it to the world round table, China, as a leading exporter, is sure to grow in power.

Investors should take note that the world is seeing China succeed, even with the cards stacked against them.  In due time, China's role in policymaking should be equal to that of the EU and the United States, a position which will only grant them more economic superiority.

Leave a Comment