Why the yuan isn’t a big winner in shift away from US dollar
- Sanctions on Russia have led to predictions of the break-up of the global monetary system, with China as the main challenger to US dollar hegemony
- Yet, for all the signs of the yuan’s rise, there are reasons to be sceptical: China’s need for stability, its murky regulatory landscape, and desire to control its currency
For a sign of the impact of geopolitical realignments on foreign exchange markets, look no further than the surge in trading volumes between the currencies of China and Russia, the two main challengers to US supremacy.
According to data from Bloomberg, monthly volumes in the rouble-yuan pair have soared 1067 per cent since Russia invaded Ukraine in late February. By contrast, trading between the rouble and the US dollar has plunged to its lowest level in a decade, based on its 20-day moving average.
Yet, for some currency strategists, concerns that the dollar’s dominant role in the global financial system is being ruthlessly exploited add impetus to forces that have caused its share of international foreign exchange reserves to fall from just over 70 per cent at the turn of the century to 59 per cent today.
In a provocative report published on March 7, Credit Suisse strategist Zoltan Pozsar argued that the sanctions-induced commodity shock marked a regime shift in the global monetary system. The new order, he claimed, would be “centred around commodity-based currencies in the East that is likely to weaken the Eurodollar system and contribute to inflationary forces in the West”.
The International Monetary Fund’s first deputy managing director Gita Gopinath has also warned about a further erosion of the dollar’s dominance. In March, she said a backlash against the sanctions could lead to a more fragmented and politicised monetary system as small groups of countries trade between themselves.
However, there is ample reason to be sceptical about the yuan’s ability to chip away at the dollar’s supremacy.
Although China has made significant strides in liberalising its financial markets, it is still trying to have its cake and eat it by opening up its capital account while maintaining control over its currency and preserving monetary autonomy. These three objectives, known as the “impossible trinity”, are incompatible, hindering the yuan’s internationalisation.
A foretaste of how the international monetary system is most likely to evolve in the coming years is in the findings of an IMF working paper published in March. The study found that none of the dollar’s main rivals – the euro, the pound sterling and the Japanese yen – have gained from its declining share of international reserves since 1999.
Internationalisation of the yuan complicated further by geopolitics
The winners were instead “non-traditional” reserve currencies. While the yuan accounted for a quarter of the shift away from the greenback, the rest of former dollar reserves flowed into smaller economies, such as Canada, Australia, South Korea and Sweden.
Not only have these markets become more liquid, they have all liberalised their financial sectors and have democratic systems of government. Barry Eichengreen, one of the paper’s authors, said every major reserve currency issuer to date has been a democracy, with “checks on executive power”.
Nicholas Spiro is a partner at Lauressa Advisory