Currencies: China Inches Closer to Respectability

China's new 100-yuan note, released in August, depicts revolutionary leader Mao Zedong.

Bloomberg's dollar spot index, which tracks the greenback against 10 major currencies, is now up for seven days consecutively -- its longest upward run in 10 months --  as central banks from competing currency areas move to loosen monetary policy.

Yesterday, the European Central Bank said it will consider expanding its bond-buying program at its December monetary policy meeting. The announcement had an immediate, significant impact on the euro yesterday and reverberated through asset markets worldwide on Friday.

Source: Bloomberg as of 4:35 p.m. EDT on Oct. 23. CAD = Canadian dollar. GBP = British pound.

Today's action by the People's Bank of China (PBoC), lowering interest rates for the sixth time in 12 months, was a bigger surprise. The bank cut its benchmark one-year lending rate and its one-year deposit rate, the latter of which is now at a new low of 1.5%. In addition, it cut banks' reserve ratio requirement, the proportion of deposits a bank must keep on hand.

The PBoC "let loose" despite China's reporting better-than-expected third quarter GDP growth of 6.9% on Monday, in line with the government's full-year target of "about 7%."

China's yuan: The road to respectability
Speaking of China and currencies: Bloomberg News is reporting that the International Monetary Fund (IMF) is likely to add the yuan to its Special Drawing Right, an international reserve asset and the Fund's unit of account.

The value of the SDR is established based on a basket of currencies: the world's two major reserve currencies -- the dollar and the euro -- and two other reserve currencies -- the British pound and the Japanese yen. It is calculated daily and quoted in dollar terms.

The SDR is not a currency, nor is it emitted by the IMF; however, it is a reserve asset and a potential claim against the freely usable currencies of IMF members. SDR holders can assert their claim in order to obtain these currencies.

The decision would have virtually no economic impact, but it has a significant symbolic value, and it's something China has been chasing for some time. Although it continues to impose capital controls, the Chinese government wishes to promote wider international acceptance of the yuan and is moving toward a more market-driven currency.

In 2009, the governor of the PBoC published a proposal to replace the dollar with SDRs as the world's primary reserve currency. The proposal is not simply jockeying for global economic primacy; it's also a risk mitigation strategy. China is the largest holder of U.S. Treasury securities ($1.5 trillion for mainland China and Hong Kong at the end of August).