A more global yuan is not a zero-sum game for China and the US

Encroachments by the yuan on the US dollar’s international turf will be evolutionary, not revolutionary – because of Chinese policymakers’ caution
Besides, given that demand for dollars has reduced the competitiveness of US exports and cost the country jobs, a more internationalised yuan could help American workers

James A. Fok

Published: 12:30am, 4 May 2023

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Across the spectrum of recent public discussion about de-dollarisation, commentators have tended to focus on negative factors and ramifications.

American monetary profligacy, fiscal incoherence and the weaponisation of the dollar, are driving other countries to settle bilateral trade in their own currencies and encouraging central bank reserve allocations to gold.

Counterarguments against the greenback’s demise tend to focus on its entrenched status and the absence of credible alternatives. China’s lack of a fully open capital account, unwillingness to run persistent trade deficits and a one-party political structure all mean that the renminbi can never challenge the dollar’s global leadership.

These arguments, however, neglect the growing attractiveness of the Chinese currency both as a store of value and as a vehicle for international trade and investment. Significant developments in China’s financial markets are changing the game board.

First, while China’s capital account is not fully open, thanks to the stock and bond Connect programmes via Hong Kong, international investment flows into and out of domestic securities markets no longer face any major barriers.

Recent extensions of these programmes to allow mainland Chinese investors to invest in the securities of international companies listed in Hong Kong and beyond are likely to draw more offshore capital raising in renminbi, particularly when Chinese interest rates are lower than those in the US (as they are now). This will further increase the pool of renminbi securities available to international investors.

Second, China has already emerged as a leading player in international trade and lending, and its drive to rebalance its domestic growth towards consumption is expected to lead to higher imports. Although this doesn’t automatically translate into a commensurate international role for the renminbi, the growing proportion of trade settled in renminbi is encouraging more counterparties to increase allocations to the Chinese currency in their reserves.

While it is doubtful that China would be willing to run protracted large deficits at the level the United States has accepted, a recent paper published by the Centre for Economic Policy Research makes a cogent case that trade deficits are not necessarily a precondition for renminbi reserve holdings growth.

If China pays for imports in its own currency, but receives dollars for its exports, countries with net exports to China can accumulate renminbi. Similarly, they can acquire renminbi through the capital account via foreign direct investment paid for with the Chinese currency.

Third, China has demonstrated improving fiscal and monetary discipline, refusing to repeat its post-global financial crisis policy errors by engaging in the massive stimulus measures that the US pursued during the Covid-19 pandemic. Some might even go so far as to argue that, with less need to pander to an electorate, China’s one-party system is less prone to monetary debasement than America’s democratic model.

While the US can still boast greater institutional checks and balances protecting private property rights, how much comfort do these provide foreigners when they have hardly prevented the expropriation of Afghanistan’s and the freezing of Russia’s foreign exchange reserves?

If other countries perceive the risks of confiscation to be similar, would they not choose the currency that is less likely to be debased?

Fourth, analyses focused on trade and geopolitical drivers often overlook the demand for currency generated by financial markets. This oversight is far from trivial, since financial flows now account for roughly 90 per cent of cross-border capital movements, vastly exceeding the trade in goods and services.

Trading in dollar-denominated derivatives creates huge demand for US Treasuries as “risk-free” assets to meet clearing house and other margin requirements. This is why this year’s launch of Swap Connect, facilitating cross-border trading in swap contracts between mainland China and Hong Kong, represents a further significant step forward for the Chinese currency.

Greater ability to hedge interest rate and other risks on Chinese securities should increase investor appetite for them. Further, the boost to trading in renminbi-denominated derivatives by international investors is likely, in itself, to increase international demand for high-quality liquid renminbi securities, such as Chinese government bonds.

Still, encroachments by the renminbi on the dollar’s international turf will be evolutionary, not revolutionary – not least because of Chinese policymakers’ cautious approach. But rather than being viewed as a threat, a more international renminbi could have significant upside for the US.

The dollar’s global utility status has always been a double-edged sword. International demand for dollars has driven up the US exchange rate, reducing the competitiveness of American exports and costing American jobs. A greater role for the renminbi would alleviate the burden borne by American workers.

Ultimately, the growing internationalisation of the renminbi is not a zero-sum game, in which the US must inherently be a loser. Nevertheless, it does call for constructive dialogue and long-range planning on the part of policymakers to ensure a more balanced and inclusive international financial system, where no country should be able to exert hegemonic power over other nations cruising the global financial highways.

James A. Fok is a veteran financial and strategic adviser to corporations and governments, who served as a senior executive at Hong Kong Exchanges and Clearing during a decade of rapid internationalisation in China’s capital markets. He is the author of the book, “Financial Cold War”.