In the midst of ongoing discussions about de-dollarization and the potential for the yuan to replace the US dollar as the world’s reserve currency, China’s stance on the matter is becoming clearer. While some speculate that China is eager to challenge the dominance of the US dollar, there are significant reasons why Beijing may not be actively pursuing this goal. Here are three key factors that contribute to China’s reluctance
Despite global debates on de-dollarization, China faces challenges and risks in promoting the yuan’s dominance
Firstly, China is cautious about liberalizing its currency and allowing unrestricted movement of capital in and out of its economy. Rory Green, Chief China Economist at TS Lombard, highlights that China wants to upset the global dominance of the US dollar on its own terms. The People’s Bank of China has implemented capital controls to maintain stability and financial security. This approach is seen as essential for an independent and sovereign monetary policy. While China is expanding the international use of the yuan, it is more focused on establishing its currency’s influence among countries it actively trades with, such as in Asia.
Secondly, China faces economic constraints that prevent it from running a persistent deficit like the United States. The US dollar’s position as a reserve currency comes with the cost of a current account deficit, driven by global demand for dollars exceeding American demand for imports. This paradox was first raised by Yale economist Robert Triffin in 1960, known as the Triffin dilemma. However, China, as the world’s second-largest economy, cannot afford to sustain such a deficit and lacks the economic capacity for it. To establish the yuan as a major reserve currency, China would need to provide substantial supplies of yuan-denominated assets globally, which is currently a challenge.
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Furthermore, China faces geopolitical risks and seeks alternative assets beyond the yuan. The dominance of the US dollar poses a significant challenge for any currency attempting to replace it as the world’s reserve currency. Currently, the yuan has a limited role compared to the dollar and the euro in global transactions and foreign exchange reserves. In April, only 2.3% of transactions conducted via SWIFT were in yuan, while the US dollar accounted for 43% and the euro accounted for 32%.
Beijing recognizes the need for a more diverse range of reserve assets to mitigate risks associated with the US dollar’s outsized dominance. Accumulating massive amounts of yuan-denominated bonds, similar to the US Federal Reserve’s holdings in Treasury securities, is not a viable option for China.
While China aims to expand the use of the yuan in trade and reserve holdings, experts suggest that it is unlikely to dethrone the US dollar as the primary reserve currency. Inertia in the global financial system, longstanding dollar-based infrastructure, and China’s economic limitations contribute to the dollar’s enduring position. Despite growing international adoption of the yuan, the US dollar remains the world’s top reserve currency, ensuring stability and security in global markets.
However, China’s efforts to promote the yuan’s internationalization should not be overlooked. Beijing has been forging partnerships with countries eager to use the yuan for trade and payments, expanding its influence regionally and gradually breaking up the US dollar’s dominance in certain parts of the world. The Belt and Road Initiative, China’s ambitious infrastructure and trade development project, has also facilitated the use of yuan in cross-border transactions, fostering closer economic ties with participating countries.
Additionally, China has been actively developing its own digital currency, the digital yuan or e-CNY. The digital yuan aims to enhance the efficiency of domestic and cross-border transactions, reduce reliance on traditional banking systems, and potentially increase the international use of the yuan. Although it is not positioned as a direct challenger to the US dollar, the digital yuan could play a significant role in reshaping global payment systems and further expanding the yuan’s influence.
Conclusion
In conclusion, while China recognizes the importance of challenging the dominance of the US dollar, it faces several obstacles that hinder its pursuit of making the yuan the world’s top reserve currency. The cautious approach to liberalizing its currency, economic constraints, and the geopolitical risks associated with the US dollar’s dominance all contribute to China’s reluctance. However, China continues to make strides in expanding the yuan’s international presence through regional partnerships and initiatives like the Belt and Road Initiative. The global financial landscape may see gradual changes in the future, but for now, the US dollar’s position as the world’s reserve currency remains secure.
Click here to read our article about De-Dollarisation and the impact of the growing use of Yuan