8 July 2020
Starting the conversation…
Michael Howell, CEO/Founding Managing Director at Crossborder Capital Ltd. and author of Capital Wars – The Rise of Global Liquidity
“Every globalisation was initiated by a rising empire …As a rising super power, the ‘One Belt, One Road’ strategy is the beginning of China’s own globalization… it is a counter-measure to the US strategy of shifting focus to the East. ” Excerpts from a speech by Major-General Qiao Liang, Chinese PLA, April 2015
COVID-19 is accelerating already nascent trends of splitting the World economy into two blocs: one centred around the US dollar and the other set to build around the Chinese Yuan. Prior to the pandemic, the US dollar-led World monetary system is proving unable to smoothly accommodate China’s international liquidity demands. China leans too heavily on the US dollar. Something has to change. Although the Chinese Yuan does not yet tick all the boxes required for an international currency, it is not too far off. China has (1) economic size and (2) fiscal probity. But she arguably still cannot (3) smoothly escalate and project military and geopolitical power, and she lacks the necessary (4) financial market depth. While the US has long enjoyed all four attributes, her future fiscal integrity will surely be more closely questioned in the wake of the policy response to COVID-19?
Could the Yuan challenge US dollar hegemony? Never say never
The growing demand to deploy precious domestic savings at home places an even greater imperative on preventing US capital shifting to China. Consequently, expect supply-chains to on-shore and an active discouragement of capital deployment into Chinese ventures. The alacrity with which the US Federal Reserve moved to provide US$4 trillion (cumulative) of precious US dollar swap lines to a ‘club’ of like-minded nations – we dub them the S15 Group, including the US – from March, 2020 is significant and should be seen as the economic equivalent of NATO. The policy aim is to contain China economically in the same way that NATO successfully contained the Soviet Union militarily through the post-war era.
Geopolitically, America also needs to prevent closer ties between China and Russia. This surely must mean luring Russia towards Europe? What role, if any, will the European Union play here? Will it inevitably evolve into a more explicitly German-led ‘Eastern’ European Union tied together by a renewed Christian nationalism?
In response, China needs to stop re-exporting the US unit and begin exporting the Yuan, so garnering the seigniorage benefits from the wider use of her currency demanded in the opening quotation. Her domestic financial markets need deepening. This will involve invoicing more goods in Yuan and developing a trade credit market managed by Chinese banks, much like drove the US dollar in the 1920s. It will also require China opening up her domestic bond market to foreigners and likely encouraging the regional take-up of a digital Yuan. China already directly controls 29% of Global Liquidity, up from 8% in 2007. This US$130 trillion pool of footloose capital may in future become far more restricted, adding to potential financial market volatility.
Could the Yuan challenge US dollar hegemony? Never say never. Money and geopolitics are co-conspirators. In 1914, the US dollar was quoted in fewer markets than the Austro-Hungarian Krone, but when the pound sterling returned to ‘gold’ a decade later, it came back benchmarked at US$4.86 to the US unit, which had risen in the vacuum of WW1 to comprise the bulk of international paper currency reserves.
Responses…
Paola Subacchi, Professor of International Economics at the University of London’s Queen Mary Global Policy Institute, and author of The Cost of Free Money
Since 2016 the Chinese yuan is one of the leading international currencies that are part of the IMF’s SDR basket – the others are the dollar, the euro, the yen and sterling. But it remains a constrained currency in terms of circulation and liquidity. ‘Managed’ convertibility and capital controls mean that the yuan remains an international currency with limitations. Approximately 25 per cent of Chinese trade is settled in yuan and outside China yuan-denominated assets are tradable in specific offshore markets such as Hong Kong, Singapore and London.
Undoubtedly there has been significant progress in the international use of the yuan since 2010 when China embarked on the internationalisation of its currency. The yuan is now the sixth most used currency in international payments, after the dollar, the euro, sterling, the yen and the Swiss franc. But its share of total international payments is tiny: 1.9% against 40.9% for the dollar.
Against this background of steady but deliberately slow progress, the renminbi, however, continues to be perceived as a potential rival to the dollar. Besides the fact that the Chinese leadership has never indicated any interest in challenging the dollar – on the contrary, the focus has always been on a multi-currency system that is less dependent on the dollar – unconstrained access to China’s domestic banking and capital market would be necessary to underpin renminbi liquidity. But this would risk undermining domestic financial stability. Hence the Chinese monetary authorities prefer to err on the side of caution and maintain the renminbi’s limited convertibility. Rather than challenging the dollar, China is likely to remain dollar-dependent for some years.