Donald Trump wants to shrink the United States’ trade deficit. In particular, the US president wants to cut America’s bilateral trade deficit with China.
That presents Beijing with a problem. The US$375 billion merchandise trade surplus that China ran with the US last year was far bigger than the US$165 billion overall current account surplus it ran with the rest of the world.
In other words, China needs the US dollars it earns by selling goods to America to pay for all the technologies it needs to license from other countries, and all the capital goods, hi-tech componentry and raw materials it must buy to power its economic development, including the 9 million barrels of oil it imports every day from the rest of the world.
With the Trump administration now aiming to squeeze China’s vital supply of US dollars, Beijing will be forced to react to the threat.
There are several ways it could do this: it could accede to Washington’s trade-war demands, it could drastically scale back its imports from the rest of the world, or it could seek an alternative means of payment to the US dollar. There are no prizes for guessing which way China is heading. Beijing is not going to comply with the demands of the economic hawks in Washington, who want it to curtail its state subsidies to industry; the government’s “Made in China 2025” industrial development policy is far too closely associated with President Xi Jinping for that to be politically realistic.
And while Beijing’s long-term policy is to reduce China’s dependence on imports of hi-tech gadgetry such as microprocessors, Chinese economic growth still relies on vast imports of commodities. Cutting back on those would jeopardise Xi’s stated ambition of attaining developed-country status by the middle of the century. Again, that’s not an option.
That means Beijing has to find an alternative to the US dollar. It doesn’t need one right away. With a US$3.1 trillion pot of foreign exchange reserves, much of it held in US dollars, China can go on paying for its imports for a considerable time simply by drawing down its accumulated US-dollar stockpile.
But with Washington policy wonks now talking in terms of a 20-year economic cold war that will permanently disrupt the global supply chains that run through China to the US, it is clear the days of China’s reliance on the US dollar both as a payments currency for international trade and as a monetary anchor are drawing to a close.
After all, if China can no longer be sure of earning enough US dollars to pay for its imports, then it no longer makes sense for Beijing to manage the value of the yuan against the US dollar.
Instead, China would like to be able to pay for its imports in yuan, effectively writing IOUs for its purchases from the rest of the world, much as the US has done for years.
But historically other countries have had reservations about accepting payments in yuan. For one thing, the yuan has been neither fully and freely convertible nor accepted everywhere around the world. That means if you got paid in yuan, there were limits on what you could do with it. You could buy stuff from China, or you could invest it in the handful of assets the Chinese authorities allowed you to buy.
On top of that, China’s trading partners have long had doubts about the yuan’s reliability as a store of value. China has a history of manipulating the yuan’s exchange rate to further its own domestic economic aims. And memories persist of late 1993, when in a single stroke Beijing devalued the yuan by 33 per cent against the US dollar – a move that many saw as the principal cause of the Asian currency crisis three and a half years later.
China has worked hard to overcome these hang-ups. It has promoted the yuan as a trade-settlement currency, allowed offshore trading in the yuan, and expanded the range of yuan assets in which foreigners can invest.
But Beijing still faced doubts, especially over the reliability of its exchange-rate policy. Recently, however, the Chinese authorities may have found a solution to their credibility problem: gold.
As the chart above shows, while over the past 18 months or so the yuan has become much more volatile against the US dollar, it has become far more stable against gold. This suggests that China’s monetary policymakers may no longer be managing the exchange rate of the yuan against the US dollar, but are instead anchoring the yuan’s value against gold.
If so, the new policy may well be boosting confidence in the yuan as a store of value among China’s trading partners. Further steps would help, such as a yuan-denominated gold futures contract on the mainland open to foreign participants, much like Shanghai’s yuan-denominated oil contract (Hong Kong’s yuan-denominated gold contract has failed to gain critical mass).
Nevertheless it stands out how in recent months, while developing Asia’s currencies have been volatile against the US dollar, they have been remarkably stable against the yuan. In short, as the US administration moves to disrupt supply chains, and to restrict the supply of US dollars to international markets via the US trade deficit, increasingly it appears to be the yuan – rather than the US dollar – that is acting as Asia’s monetary anchor.
If so, and if the trend persists and beds down, China will have gone a long way towards setting up a new Asian monetary zone based on the yuan, and towards establishing itself, rather than the US, as the region’s dominant economic power. ■
Tom Holland is a former SCMP staffer who has been writing about Asian affairs for more than 25 years