Opinion

China’s yuan nowhere near cracking US dollar hegemony

For all Beijing's ambitions of cracking the hegemony of the US dollar in the face of Trump administration sanctions, the yuan still has a long way to go.

By: Date: October 30, 2020 Topic: Global Economics & Governance

The opinion post was originally published in Nikkei Asia Review.

The yuan is higher than it has been in more than two years, and foreigners are suddenly showing interest again in holding the Chinese currency.

Earlier in the decade, Beijing brought the yuan into the spotlight through an aggressive effort to take the currency overseas through swap agreements with foreign central banks and offshore bond issuances denominated in the currency.

This time, foreigners are coming to China to get yuan. Chinese assets stand out at a time interest rates in much of the world are at zero or below and many currencies are sagging. Beijing has meanwhile been making access easier for foreign buyers.

Yet for all Beijing’s ambitions of cracking the hegemony of the US dollar in the face of Trump administration sanctions, the yuan still has a long way to go. While this week’s meeting of the Communist Party Central Committee looks likely to take up the cause of yuan internationalization, the currency will not be taking the greenback’s place on the world scene any time soon.

Available data suggests that after plunging abruptly in 2015, international use of the yuan started to recover just last year. This year, foreigners have been snapping up yuan to put into domestic Chinese bonds and stocks, with holdings of such bonds alone rising by more than a quarter to 2.8 trillion yuan ($419.3 billion).

It goes without saying that the general weakness of the dollar since the COVID-19 pandemic began pounding the U.S. economy in March has been a blessing for the Chinese authorities’ attempts to attract inflows, boosted by the juicy interest rate differential between the two nations’ benchmark government bonds.

Looking deeper into current international use of the yuan, trade settlements in the Chinese currency have slightly picked up since last year, especially in services transactions.

Central bank reserves held in yuan have not been rising much though. Yuan loans and deposits held by overseas institutions also remain minimal.

Significantly, notwithstanding China’s growing exertion of economic, political and even cultural influence, the yuan has not yet become an official reference point for other Asian currencies or for private markets in general, with the exception of oil futures and a few other commodities.

What has been rising substantially is the value of international payments intermediated through the China International Payment System, a yuan-based alternative to the dollar-denominated SWIFT system based in Brussels. The volume of such payments processed through CIPS has been rising more slowly, indicating the network is mostly being used for high-value transactions.

What all of this seems to imply is that China is indeed fully aware of the risk of conducting most of its international trade and investment transactions in dollars and of holding most of its foreign assets in dollars. The way to reduce this dependence, beyond diversifying into use of other foreign currencies as has also been happening, is to boost the yuan.

Previously, international use of the yuan was outsourced to offshore financial centers, especially Hong Kong. This created a kind of dual market in yuan, one offshore and one onshore.

As the onshore market remained within China’s capital controls and allowed limited daily movements, traders could find arbitrage opportunities between the yuan’s varying valuation in the two markets.

This time around, the onshore yuan market is king, with Beijing keen to attract as much capital inflow as possible. Rather than keeping their yuan parked offshore, foreign investors are expected to enter the mainland even without full assurance taking out funds will be quicker or easier than in the past.

The notion is that Chinese capital markets are too big to be missed and that the growth differential between China and the rest of the world will ensure that the relative rate of return from yuan-based investing will remain positive.

Looking at the increase in portfolio inflows into the mainland, it is evident investors are buying into this story but maybe with a bit different reasoning.

For some international investors, the time is ripe for a carry trade of borrowing cheaply in dollars in the U.S. and then investing in yuan assets in China.

But any closing of the interest rate gap or renewed weakness in the yuan could change that picture dramatically. If the Chinese economy suddenly decelerates and the People’s Bank of China steps in by cutting rates or nudging the yuan lower, such foreign investors could take flight once again.

It would not be the first time. A sudden move by the PBOC in March 2014 to double the daily trading band of the Chinese currency spooked investors then, causing losses to those who had been counting on an ever-rising yuan.

A fully open capital account remains a key prerequisite. These days, 2030 seems to be China’s new target for achieving that, with the previous goal of 2020 fading from memory.

But the growing reach of U.S. sanctions and policy moves to drive financial decoupling from China could further set back Beijing’s efforts. Rather than taking the dollar’s place globally, the yuan might then emerge at best as a reserve currency within an ecosystem of linked nations, with the dollar remaining the reserve currency for the rest of the world.

That would be a win for yuan internationalization, but not a knock out.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read article More on this topic More by this author
 

Opinion

Grading the big pandemic test

COVID-19 almost one year on, it is time to assess who passed the test, and who failed.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: November 27, 2020
Read article More on this topic
 

Blog Post

Europe is losing competitiveness in global value chains while China surges

The European Union owes much of its economic weight to its regional value chain and integration into the global value chain. But the EU’s global value chain role is shrinking, and while EU trade integration with China is increasing, it is mainly to China’s benefit, undermining the EU’s external competitiveness.

By: Alicia García-Herrero and David Martínez Turégano Topic: Global Economics & Governance Date: November 27, 2020
Read about event More on this topic
 

Past Event

Past Event

How to keep a competitive environment while engaging with non market economies?

How can we ensure fair competition between European firms and Chinese state-backed players?

Speakers: Julia Anderson, Helge Berger, Michiel Boots, Alicia García-Herrero, Carles Esteva Mosso, Frédéric Jenny, Georgios Petropoulos, Cian Ruane, Hylke Vandenbussche and Guntram B. Wolff Topic: Innovation & Competition Policy Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: November 19, 2020
Read article More by this author
 

Podcast

Podcast

Sizing up the world's largest trade deal

What should be Europe's strategy towards the Regional Comprehensive Economic Partnership (RCEP)?

By: The Sound of Economics Topic: Global Economics & Governance Date: November 18, 2020
Read article More on this topic More by this author
 

Opinion

RCEP might not stop reshuffling of Asian value chains

China is no doubt bound to benefit, but other members of the regional trade pact may benefit even more

By: Alicia García-Herrero Topic: Global Economics & Governance Date: November 17, 2020
Read article Download PDF More on this topic
 

External Publication

Hong Kong’s Intermediary Role on Funding the BRI: How does it fare against Singapore?

A look into the intermediary role of Hong Kong in financing cross-border Belt and Road Initiative projects and compare it with Singapore, a similar offshore financial center and competitor.

By: Alicia García-Herrero, Gary Ng and Hanrui LI Topic: Global Economics & Governance Date: November 4, 2020
Read article More on this topic More by this author
 

Opinion

Fifth Plenum maps China’s response to a more hostile world

'The Communist Party has acknowledged that the outside world now is more of a risk than an opportunity.'

By: Alicia García-Herrero Topic: Global Economics & Governance Date: November 3, 2020
Read article More on this topic More by this author
 

Opinion

Globalisation needs rebuilding, not just repair

An attempt merely to restore the pre-Trump status quo would fail to address major challenges; the task ahead is one of rebuilding, rather than repair. It should start with a clear identification of the problems that the international system must tackle.

By: Jean Pisani-Ferry Topic: Global Economics & Governance Date: October 29, 2020
Read article More on this topic
 

Opinion

Politics, not economics, demands a strengthened international role for the euro

Not just the EU but also other countries, particularly China, need a defence against weaponisation of the dollar.

By: Alicia García-Herrero and Federico Steinberg Topic: European Macroeconomics & Governance Date: October 28, 2020
Read article More on this topic More by this author
 

Podcast

Podcast

A tale of two presidencies

With the US presidential elections around the corner we asked ourselves: what would a Biden administration look like? And what would a(nother) Trump administration look like?

By: The Sound of Economics Topic: Global Economics & Governance Date: October 28, 2020
Read about event More on this topic
 

Past Event

Past Event

The future of EU-US trade relations after the US election

What shape will the trade relationship between the EU and the US take in the coming years?

Speakers: Cecilia Malmström, Adam Posen and Guntram B. Wolff Topic: Global Economics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: October 26, 2020
Read article More on this topic More by this author
 

Opinion

ECFA重要性遞減 台灣出口未來關鍵 在保持科技優勢和出口多元化

從地緣政治角度來看,ECFA自動延續無疑是個好消息,但協議對台灣經濟的直接影響較過去變得有限。雖然台灣對中國大陸的出口仍然重要,但ECFA占整體出口的重要性因資通訊科技產業快速發展而縮小。由於台灣在全球製造業供應鏈遷移和價值鏈重組中占有重要位置,未來對美國和東南亞出口預計將會加速。

By: Alicia García-Herrero Topic: Global Economics & Governance Date: October 20, 2020
Load more posts