Will the Yuan dethrone the Dollar? Not so fast
Recent crises such as fears surrounding inflation, recession, and war, have led nations, institutions and individuals alike to seek out “safe havens” to shore up their wealth. For the past century, this safe haven has been the US dollar given its position as the world’s reserve currency of choice. China has been striving towards offering the Renminbi as the go-to alternative to the greenback in a multipolar world. Whether it succeeds is another question.
China, an economic giant, is soon to become the world’s largest economy. Despite its status, China’s currency, the Renminbi, is not currently the primary reserve currency nor the second. This is something Beijing sees as a possible limitation to its economic potential and, perhaps more importantly, its influence.
The People’s Republic has been building the infrastructure, architecture and relationships for the Renminbi to act as a new anchor currency to the US dollar (Crawford, 2022). Beijing has promoted its use in the Asia-Pacific, regional blocs and Belt and Road Initiative countries, and especially among those who frown upon US dollar dominance (Lockett, 2019; Sputnik News Agency, 2022; OECD, 2018).
Presently, the Chinese Yuan is the third most common reserve currency behind the greenback and the Euro. With China’s economic size, the greatest tool Beijing has to push the Renminbi as an alternative is through trade (Hancock, 2022). Every time trade is conducted, parties need to choose either to settle in the importer’s currency, the exporter’s currency, or a third currency (i.e. US dollar).
China, by far the biggest manufacturer of goods globally, sells its goods all over the world (World Bank, 2021). It is extremely likely that someone would find at least one product made in China in their close proximity. In manufacturing these goods, China imports a titanic volume of raw materials, fuels, machinery and parts (Gao, Qiu & Woo, 2021). With this, all trade provides Beijing with an opportunity to request for payments to be denominated in Renminbi.
In an unexpected turn, Russia’s invasion of Ukraine has given China the optimal climate to highlight the drawbacks of the US dollar and the viability of its own Yuan. Western sanctions against Russia, including freezing her foreign currency reserves, have shown to other nations that their own foreign currency reserves are not untouchable (DiCamillo, 2022). These sanctions have shaken the faith in the greenback, demonstrating that Washington can arbitrarily and unilaterally, based on its own policy considerations, choose to cut off reserves of a foreign nation (Bretell, 2022).
Whilst US partners are unlikely to be sanctioned, non-US allies may be more inclined to hedge their risks and diversify, seeking out currencies that may not be so easily severed by the West. China’s Renminbi consequently presents itself as a strong alternative. Since the invasion, Beijing has also indicated its willingness to continue to do business and trade with countries shunned by the West (Chimits & Hmaidi, 2022).
In this light, China has adopted Churchill's pragmatic saying, “never let a good crisis go to waste”. Beijing has recognised the importance of the BRICS gathering, particularly since the Ukraine War and Russia’s exclusion from the Western-dominated system. Trade between BRICS members has increased 38 percent since the start of 2022 (Rosen, 2022). With the meeting of the bloc in July 2022, China has used this opportune climate to push for the group to adopt the Renminbi as the de facto currency of choice for trade (Turner, 2022).
But while China has sought to increase the Yuan’s attractiveness among these regional collections and her economic partners, the currency still only holds a minute share in global transactions. Compared with the US dollar’s high of 42 percent (Goldberg, Lerman & Reichgott, 2022), the Renminbi accounts for just over two percent of global currency reserves (Glover, 2022).
As part of its flagship Belt and Road Initiative, China has issued loans and lines of credit to participating countries, providing an opportunity to increase the Yuan’s prevalence and internationalisation (Liang, 2020). Having denominated in Renminbi, China is effectively forcing these nations to maintain large reserves of its currency to ensure repayment, or the country faces the risk of defaulting. Yet, these measures only extend to closely aligned economies such as Cambodia and various African nations (Xinhua News Agency, 2013; Dahir, 2018).
While China has actively negotiated currency swap deals (Zhang, Zhang & Woo, 2022), established their version of SWIFT (the ‘Cross-Border Interbank Payment System’) (Eichengreen, 2022), and introduced a digital Renminbi (Deutsche Bank, 2021), its campaign to present the Yuan as a “sanction-proof” alternative to the greenback is plagued with inherent and deep-rooted issues.
China has a reputation for enacting excessive punitive economic actions on its trade partners, including Australia, Lithuania, and Taiwan (Walker, 2020; Andrijauskas, 2022; Tan, 2022). As a case in point, the United States sanctioned Russia for prosecuting an aggressive war against a fellow sovereign nation, while Beijing unofficially sanctioned Australia for calling for an investigation into the origins of COVID-19 (Walsh, 2021).
Holding reserve currency is comparable to holding shares. The holder would want the issuing country to be run effectively, run sustainability and stably, and would want the government to avoid tensions and controversy. China’s actions do not necessarily emanate stability, or any of the listed.
The Communist Party’s incessant need to control every aspect of China’s society and economy has inadvertently dampened its own currency ambitions. For instance, Chinese citizens are prohibited from taking up to US$50,000 out of the country annually (Lee, 2021). This law lays bare two phenomena: one, Beijing believes there is a need to effectively imprison the wealth of its citizens onshore, and two, it is so uncertain about the value and volatility of the Renminbi that the law itself is denominated in US dollars.
When compared to the US dollar, the Chinese Yuan faces even greater hurdles. The preeminent position of the greenback as the world’s reserve currency of choice is attributable to several factors (Bartholomeusz, 2022); the liquidity in US financial markets, the strength of regulations in those markets, the transparency of the American judicial system, and the independence of its central bank (Best, 2022; International Monetary Fund, 2005; Federal Reserve Bank, 2019).
In contrast, China’s financial markets are not fully developed and are subject to capital controls (Prasad, 2016). The Renminbi is also tightly regulated, not freely floating, and far from being primarily driven by market forces (China Power - CSIS, 2016). China’s judicial system is also notoriously clouded and untrusted, and its central bank, the People’s Bank of China, is under direct supervision from Zhongnanhai (Zhu, 2021; CNBC, 2019; Wildau & Mitchell, 2021).
Despite the speculation and commentary, the Yuan, in the short-term, does not look likely to be a viable alternative to the dollar. Although Renminbi may be preferred among small regional blocs, China’s close economic partners and countries traditionally at odds with the West, it will struggle to penetrate and find favour in other nations.
All in all, China’s international ambitions for its currency are simply held back by its domestic and foreign policies, inherent characteristics, and the persistent strength of the dollar.
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