Watch the Peg…to the SDR?
November 28, 2019
The elections in Hong Kong at the weekend produced a huge swing to the Pro-democracy parties. All eyes therefore will now be on the Hong Kong Legislative Elections next September. Currently only half of the 70 person council are voted by the electorate, the others are voted by business interests. We would expect there to be an offer for Universal Suffrage for these, not least because it is one of the ‘demands’ the US has made in its new Hong Kong Human Rights and Democracy Bill that has just been signed. In fact this would not be too much of a concession for China as this has been offered previously.
Having said that, the Chinese are unlikely to be happy about US interference in what it regards as its domestic affairs and in our view this can only accelerate the response already underway to break from the US $ and the SWIFT payments system. As discussed elsewhere, the more the US seeks to ‘weaponise’ the $ and their banking system as a tool of foreign policy the more the Eurasian bloc will seek alternatives. Russia in particular is keen on adopting another way of transacting to avoid US sanctions. Indeed at the latest BRICS summit the concept of a single common cryptocurrency was widely discussed as a means for settling intra BRICS transactions.
That may well come to pass – and naturally the usual suspects are getting excited about pegging things to gold – highlighting that the Chinese have almost $1trn of reserves in Gold now. However, perhaps of more interest is the idea of the use of the SDR, especially now that China is effectively loosely managing its currency against a basket rather than just the $. In a fascinating paper for the Journal of Risk and Financial Management earlier this year, Matthew Harrison and Geng Xiao suggest that a unilateral embracing of the SDR by China could kickstart a new SDR based ecosystem. They think it is an idea who’s time has come and in the light of the intensified move away from the $ this looks extremely interesting.
The SDR is an accounting unit for IMF reserve balances and is a basket of US$ (41.73%), Euro (30.93%) Chinese RMB – since October 2016 – (10.9%) Japanese Yen (8.33%) and British Pound Sterling (8.09%) and has long been promoted as a solution to the widely recognised imbalances of a single currency, $ based system. However, one of the main problems preventing wider use of the SDR has been a liquidity premium – issuing debt in SDRs would be more expensive. Moreover as Harrison and Xiao point out, widespread adoption of the SDR would require the sort of international cooperation that is sadly lacking at the moment.
However, there is a strong case that they make for a unilateral adoption by China that could kick start an ecosystem. For a start China would actually have a liquidity benefit from issuing in SDR rather than Rmb and in doing so would achieve a form of Rmb internationalisation without the risks of capital flight. It would also be seen as a multilateralist move, rather than supplant the $ with the Rmb, even regionally, they would be embracing the major trading currencies which would be much more acceptable. Meanwhile of course they would be putting themselves in the box seat for setting the rules for a new monetary order.
Bottom line, the idea of China embracing the SDR appears to be, in the words of Harrison and Xiao, “an idea who’s time has come”. There are obviously significant implementation issues which they discuss in their paper but one point they make – and which triggered this post – is the role of Hong Kong in facilitating this new market and in addition to monetary limits or quotas, to have an initial geographic limit to Corporate SDR issuance, which they suggest to be the Greater Bay Area. What then could be more fitting than to peg the Hong Kong Dollar to a wider basket of currencies, in effect to the SDR?