Yuan has dollar looking over its reserve currency shoulder
New IMF report shows dollar is slowly but surely losing its dominant place at the center of the global financial order
The financial world has no better arbiter of whether the dollar’s days as the reserve currency are over than the International Monetary Fund.
In a new report, the IMF concludes we’re not quite there yet. But, it finds, the clock is ticking, perhaps faster than US Treasury Secretary Janet Yellen might realize and that China’s currency is the key beneficiary of this historic pivot.
Most interesting, perhaps, is Barry Eichengreen co-authored the study, one surely being discussed at the highest levels of government. Eichengreen, who teaches at the University of California, Berkeley, is a top IMF adviser who made his name in financial circles during the 1997-98 Asian crisis.
His sense that the dollar is losing its place at the center of the economic solar system isn’t partisan or ideological. It’s based on empirical evidence.
“The shift” away from the dollar “is broad-based,” Eichengreen argues, along with IMF economists Serkan Arslanalp and Chima Simpson-Bell. “We identify 46 active diversifiers that have shifted their portfolios in this direction, such that they now hold at least 5% of their reserves in non-traditional currencies.”
In exploring the “decline in the dollar share of international reserves,” Eichengreen and his colleagues find that the “shift out of dollars has been in two directions: a quarter into the Chinese renminbi, and three quarters into the currencies of smaller countries that have played a more limited role as reserve currencies.”
These include the Australian dollar, Canadian dollar, Singapore dollar, South Korean won and Swedish krona. Clearly, though, the focus is on Beijing’s steady success in transforming the yuan into the dollar’s main nemesis.
The upshot is that the yuan, for all its drawbacks, is the only monetary unit with the scale to dislodge the dollar. That’s evidenced by the fact that neither the euro nor the British pound nor Japanese yen is benefitting from doubts about the dollar.
Historically, these members of the IMF’s Special Drawing Rights are Plan B for central bankers and investors everywhere.
Moving past the dollar
No more. “A characterization of the evolution of the international reserve system in the last 20 years is thus as the ongoing movement away from the dollar, a recent, if still modest, rise in the role of the renminbi, and changes in market liquidity, relative returns and reserve management enhancing the attractions of nontraditional reserve currencies. These observations provide hints of how the international system may evolve going forward,” the reports says.
The report doesn’t reference Ukraine at all. Nor is Russia necessarily a major consideration for where the dollar’s future lies. After all, Vladimir Putin’s demands that Russian gas is paid for in rubles is being met with a loud thud in Europe.
Instead, Eichengreen and his colleagues suggest the deciding factor for currency dominance won’t be the maneuvers by some China-Russia-Saudi Arabia axis or via currency swap arrangements, but the old-fashioned way: methodical and transparent steps to build strong economic foundations under the yuan and attract more investment over time.
Here, it’s hard not to admit Xi’s team, often led by reformers at the People’s Bank of China, isn’t making notable progress. President Xi’s China, Eichengreen notes, has embarked on a process of currency internationalization, driven by growing imports and exports, Belt and Road investments, a global network of yuan currency swaps and official clearing banks and, of course, entering the IMF’s SDR basket.
The issuance of the first major central bank digital currency, the e-CNY, is a case in point. While the Federal Reserve in Washington and Bank of Japan in Tokyo “study” the issue, the PBOC is well past the beta-testing stage.
“On this dimension” Eichengreen notes, “the dollar hasn’t become more dominant. It hasn’t even maintained the dominance of prior years.”
America’s national debt topping $30 trillion at a moment when Washington’s dysfunction has brought virtually all legislation to a halt is hardly promising. So is a Fed that’s falling further and further behind the inflation curve.
Of course, Washington’s response to Russia’s Ukraine invasion could backfire on the dollar.
“An unintended consequence of stringent sanctions on Russia, which include blocking its access to hundreds of billions of dollars of currency reserves, could be accelerating de-dollarization, or efforts to build alternative financial arrangements that don’t depend on the US dollar,” says economist Zongyuan Zoe Liu at the Council on Foreign Relations.
Bypassing sanctions
Liu notes that existing de-dollarization mechanisms date back to 2014, when China-Russia currency swaps helped Moscow bypass US sanctions imposed after it annexed Crimea. Since then, Russia has used the swap lines numerous times and, by Liu’s count as of early March, some $77 billion of its reserves are in assets denominated in yuan.
Xi’s China would surely support deepening these efforts and broadening a yuan-centric financial infrastructure based around its Cross-Border Interbank Payment System, or CIPS, and UnionPay bank card network. This would increase the yuan’s status in currency circles and Beijing’s financial autonomy.
At the same time, Liu says, sanctions “could also propel China and Russia to push for a broader de-dollarization coalition in multilateral institutions,” including the grouping of emerging economies Brazil, Russia, India, China and South Africa, or BRICS, and the Eurasian security pact known as the Shanghai Cooperation Organization.
Though the BRICS have had a rough couple of years of Covid-19 disruption, it’s already “become a platform for efforts to build an alternative financial system, with the group’s development bank raising funds in local currencies as part of its goal to ‘break away from the tyranny of hard currencies,’” the dollar in particular, Liu says.
Economist Baizhu Chen at the University of Southern California agrees that worries are growing among some developing nations that “economies could be held hostage to US policies because the dollar is dominant.”
Last month, Fed Chairman Jerome Powell conceded the Ukraine crisis may hasten China’s efforts to topple the dollar-dominated international payments infrastructure.
Then again, things could go the other way, says Mark Mobius, founder of Mobius Capital Partners. The hotter geopolitics get, Mobius says, the globe could be faced with a scenario where “the dollar is still strong and will probably get stronger if tensions continue to escalate.”
Yet beyond all this geopolitical noise is Yi Gang’s team at the PBOC taking care of the business of increasing trust in the yuan. It was Governor Yi’s predecessor Zhou Xiaochuan who in 2016 secured a place for the yuan in the IMF’s top-five currency club along with the dollar, euro, yen and pound.
China’s to-do list
Since then, China has made notable strides in increasing yuan transparency and liquidity. Xi’s regulators also increased the range of channels for foreign investors to access Chinese stock and bond markets. Mainland shares have since been added to the MSCI index, while government bonds were included in the FTSE Russell benchmark.
Yet China’s to-do list is still a lengthy one. Brookings Institution economist Otaviano Canuto argues that the “qualitative leap towards the internationalization of the Chinese currency as a full reserve currency will only happen when confidence in its convertibility is sufficient” to convince central banks and investors to load up on yuan.
Shorter-term challenges abound, too. One is ensuring that Xi’s massive Covid-19 lockdowns in Shanghai and elsewhere don’t do significant damage to China’s 5.5% economic growth target. Another is following through on hints that the worst of Xi’s crackdowns on Big Tech and property developers are over.
Even so, as Eichengreen’s IMF study finds, the move away from the dollar is more credible this time than in, say, 2008. Back then, warnings abounded about the dollar’s demise. Since then, though, it soared as the Fed took on an outsized global role in stabilizing world markets.
Even today, Bank for International Settlements data shows that almost 90% of trades in the more than $6.5 trillion-a-day foreign-exchange market involve the dollar.
It’s time, though, that Yellen’s team began looking over its shoulder. In January, the yuan’s share of global payments hit a record high of 3.2%, according to the Society for Worldwide Interbank Financial Telecommunication, known as SWIFT. That was up from 2.7% a month earlier.
The yuan’s rise, in other words, was gaining speed well before Putin’s war shook up the geopolitical order. And as long as Xi’s government continues to get the financial fundamentals below the surface right, it’s a megatrend of infinite impact.
Follow William Pesek on Twitter at @WilliamPesek