For a while, China has been trying to challenge the global dominance of the US dollar as the world’s reserve currency, a position it has held since the Bretton Woods Accords in 1945.
Beijing took several steps towards this direction. Since 2011, Beijing has signed bilateral currency swap agreements with several members of the Shanghai Cooperation Council (SCO), and on the 2022 meeting of the SCO, a road map was accepted for using local currencies in trade and developing alternative payment and settlement systems.
Russia’s swift exclusion from global financial markets gave a huge push to this effort as probably others will also follow Moscow’s example in adopting the yuan.
In 2022, the yuan has reportedly replaced the U.S. dollar as the most traded currency in Russia, and in March 2023, it overtook dollar to become most-used currency in China’s cross-border transactions (48.4 percent versus 46.7 percent). Official data showed that cross-border payments in yuan rose to a record $549.9 billion, a sharp increase compared to February ($435.5 billion).
The process didn’t start after Russia invaded Ukraine. The U.S. dollar has been continuously losing its power, as its share in central banks’ foreign exchange reserves has been diminishing since 1999. Back then, the US’s share was more than 70 percent. In 2022, it was less than 60 percent, the lowest percentage in 25 years. (To put it in perspective, the euro, the second biggest ‘shareholder’ has 20 percent.)
It’s too early to bury the dollar just yet, as it still holds a significant advantage.
For a wide variety of reasons, it is also unlikely that, either in the short or in medium term, it would lose its position as the world’s most important currency, not in the least, because as of now, the most important commodity, oil (and gas) is priced in dollar.
Another reason is that Chinese and American capital markets work differently: Beijing still keeps the capital market strictly restricted, it lacks transparency and predictable legal environment, its banking and monetary system does not enjoy the same level trust and confidence as its American counterpart. Even China is doing most of its international transactions in dollars.
However, the news signal yet another significant step towards a multi-currency world.
Not one, in which the yuan replaced the dollar, having achieved the same level of dominance. But one, in which the dollar is less important than it was before and trade is carried out in many different currencies. Nouriel Roubini has predicted the same, claiming that the unipolar world would give way to a bipolar world, in which China will act as the other axis.
Both the geopolitical risks (no country might be immune and could find itself in the “illustrious” company of Russia, Iran or Venezuela, in addition to increasing China-US rivalry) and economic dynamics (China’s share in global trade) have an accelerating effect towards the move away from the dollar.
In this regard, sanctions against Russia might have backfired: the more eagerly the U.S. (and the West) uses sanctions, the more inclined third countries might feel to search for alternatives, or at least some sort of diversification. The decision to freeze the $600 billion worth Russian assets has prompted even Saudi Arabia to signal its openness to trade in currencies other than the dollar.
Less dependence on the dollar would also allow third countries to avoid or mitigate the (negative) effects of the FED’s policies and the ups and downs of U.S. economic growth.
China has one more advantage: according to IMF data from 2022, Beijing was the largest trading partner of 61 countries. (The US, on the other hand, was the largest trading partner to only 30.) And the volume is growing. Trade between Brazil and China grew 10 percent in 2022 compared to 2021, reaching $ 150 billion.
Not long ago, the Renminbi Liquidity Arrangement meant a significant boost for the yuan. The deal signed between China’s The People’s Bank of China and five other central banks meant to increase the supply of yuan held in foreign reserves as each signatory party agreed to contribute a minimum of 15 billion yuan to their reserve holdings.
The yuan is still only a minor player on the playing field, hasn’t even reached 3 percent in all global transactions on a yearly basis: a far cry from the euro-yen- pound sterling trio that, on the other hand, is also far from the dollar. Other competitors, like the Swiss francs, are also trying to get a slice of the cake.
But the voices demanding ‘de-dollarization’ are getting stronger.
On the latest meeting of ASEAN finance ministers and central banks, there was serious discussion about diminishing reliance on the U.S. dollar (and the yen and the euro) and strengthening local currencies.
The yuan has been slowly but steadily climbing upwards: in March 2023, its share of global currency transactions for trade finance rose to 4.5 percent.
As in the ancient fable of the turtle and the hare, the slow and steady pace might eventually lead to a win in the end.