Interesting article on a hot topic in other threads I found interesting and wanted to give it it's own thread.

http://foreignpolicy.com/2015/06/16/...ng-rights-imf/

A lot of hyperventilation has lately been devoted to the future international role of China’s currency, the renminbi (RMB). The latest flurry of excitement centers on China’s bid to have the RMB included in the basket of currencies represented in the Special Drawing Rights issued by the International Monetary Fund. According to accepted wisdom, the RMB’s inclusion in the SDR basket would be a landmark step, formal recognition of its coming-of-age as a global reserve currency. SDR status, many say, would give central banks the green light to add RMB to their reserves and encourage investors to pour money into Chinese stocks and bonds.

But SDR status is a red herring. What really matters is not whether the IMF uses the RMB, but who else does.

If anything, inclusion in the SDR basket would be a political gesture, not a financial or economic game-changer.
That may seem a strange thing to say, given the obvious stock Chinese officials place in winning SDR status. Surely, they wouldn’t devote so much effort and make it such a high priority, if it wasn’t really important. But China wouldn’t be the first country to mistake the form of reserve currency status for the substance.

There are two keys to any nation’s currency functioning as a global reserve currency: It must be desirable (as both a means of exchange and store of value), and it must be accessible (people can accumulate bank balances in it abroad). Official recognition can acknowledge these realities, but does not fulfill them, as the United States found out in the wake of World War II.

In 1944, the Bretton Woods Conference designated the U.S. dollar as the world’s reserve currency, linked to gold (which the United States owned virtually all of). Washington also made sure that exchange rates to the dollar were fixed to ensure its continued dominance as an exporter. But after the war, the problem quickly became apparent: Europe had no dollars, and no way to earn them. Unless the United States was willing to supply dollars via trade, aid, or investment — in other words, by running a balance of payments deficit — a global economy depending on the dollar as its reserve currency would collapse.

The solution to this dollar shortage was the Marshall Plan, followed by a series of currency devaluations that put its trading partners on a more competitive footing with the United States. Eventually, Washington essentially exported dollars by running large and persistent trade deficits — a state of affairs that continues to this day and would be unsustainable if the United States did not remain a profitable place to invest.

SDR status may fall far short of Bretton Woods, but the principle still operates. Any country that wants its currency to actually function as an international reserve must supply the rest of the world with claims in that currency, either by running trade deficits or by providing large amounts of aid or investment capital. Until now, at least, China’s development model has been based on precisely the opposite: running trade surpluses and attracting foreign investment. In the process, rather than exporting its own currency, it has imported an astonishing $4 trillion in other countries’ currencies, which it holds as central bank reserves. (In the past few years, China has seen some capital flow outward, drawing down on those huge foreign currency balances by a few billion dollars.)

So where do SDRs fit in? SDRs are a unit of account, assigned a value (based on a basket of widely used and traded currencies), and allocated to countries by the IMF. Think of them as vouchers, which can — in theory, at least — be exchanged for actual currencies. If the RMB were added to the SDR basket — along with the dollar, euro, pound, and yen — it could be argued that countries holding SDRs would be holding some sort of claim on RMB as part of their reserves. The official imprimatur of the IMF might also encourage central banks to hold RMB directly, on their own.

It’s possible — but where would the RMB come from? Any RMB sent abroad, in excess of China’s (currently modest) balance of payments deficit, would result in China accumulating that much more foreign exchange reserves of its own. In effect, it would be a kind of swap, which could be done (as long as both central banks are willing) with any two currencies. Even using RMB to settle China’s payments deficit would leave it stuck holding the excessive quantities of foreign currency reserves it has already stockpiled. Far from eclipsing the U.S. dollar as the lead global currency, sending RMB abroad — absent a significant shift in China’s balance of payments — would only perpetuate, and perhaps even exacerbate, China’s own reliance on (and exposure to) the dollar and other foreign reserve currencies.

Others, including the authors of a recent report by Barclays, argue that SDR status would establish the RMB as a “safe asset,” which would encourage investors to buy Chinese stocks and bonds, thereby paving the way for it to serve as a reserve currency. It is certainly true that more liquid, better-developed capital markets in China would make it a great deal more attractive to hold RMB.

But the question, again, is where does the money come from? If foreigners are buying Chinese bonds (or even non-Chinese bonds) with RMB they earned selling (net) exports to China, or if they are buying Chinese goods (or even non-Chinese goods) with RMB they borrowed from Chinese lenders, then the RMB has truly gone global, supplied by (initial) Chinese balance of payments outflows.

But if foreign investors are simply changing their own currency into RMB in order to buy RMB assets in China, that’s a capital inflow. From a flow of currency perspective, it’s no different from a tourist changing U.S. dollars into RMB at the Beijing airport, or the foreign direct investment that’s been flowing into China for years. Each of these transactions involves China importing foreign currency in exchange for goods and assets, not exporting RMB. To the extent that SDR status makes China a more attractive magnet for foreign investors, it actually raises the hurdle that much higher for China to supply the world with RMB reserves.

Many observers seem to believe that anything that raises the RMB’s profile puts it on track to becoming an international reserve currency. This is far from the truth.

Adding the RMB to the IMF’s SDR basket would certainly raise its profile, but would do nothing to help — and could even complicate — the ability of other countries to acquire meaningful reserve holdings of RMB. Just as was true for the U.S. dollar, the key to the RMB’s future role depends not on official designations from above, but on the balance of payments. For the RMB to function as a reserve currency, China would have to develop a profoundly different relationship with the rest of the world economy from the one it has now — a change it is far from clear the Chinese are willing to embrace.