Global Courant
China has expressed its dissatisfaction with the role of the US dollar in the international economy and its intention to internationalize the RMB as an alternative international currency.
A popular story tells us that since China is now the second largest economy in the world, the largest trading nation and the largest trading partner of 120 countries, it is inevitable that the RMB will play a greater role in the international economy. A side effect of the transition to a more RMB-oriented international economy will be the loss of US economic power.
If the United States continues to weaponize its dollar hegemony, it will only accelerate the decline of the dollar. The United States would be best served by refraining from using economic statesmanship to pressure countries into complying with their wishes.
China has already developed the “financial plumbing” necessary to facilitate the internationalization of the RMB. The country has developed an alternative cross-border payment system (CIPS) to rival Fedwire and the Clearing House Interbank Payments System. China’s Alipay and Tencent salary have now also been widely adopted abroad.
And since 2020, China has been testing its Digital Currency Electronic Payment network, which has the potential to accelerate the international use of the RMB.
Perhaps more telling than what China has done to facilitate the international use of the RMB is what it has not done. As China has internationalized its own balance sheet, it has remained firmly focused on the dollar.
China is still bound by a policy of exchange rate targeting and needs its own dollar reserves – partly because of its high propensity for domestic capital flight – which is problematic when promoting greater international use of the RMB. China has yet to liberalize its capital account to make the RMB freely convertible – a condition for reserve currency status.
China’s capital markets remain underdeveloped with both regulated and limited foreign participation. Foreign issues in RMB remain small.
Nor has China shown a willingness to become a net supplier of RMB to the world by running current account deficits, preferring instead to lend RMB to other central banks through swap agreements.
While China has facilitated the use of the RMB in trade, it is still far from having the overarching macroeconomic structure that would make it a candidate for reserve currency status.
This is important because it is through trade that countries earn the foreign exchange needed to pay off their foreign currency-denominated obligations. Earning RMB through trading is a risky way to earn income to pay off a dollar-denominated debt.
China wants its currency to match the dollar in international trade and settlements, but it’s not that simple. Image: iStock
There is no sustainable dichotomy between the currency denomination of trade and the currency denomination of a country’s foreign assets and liabilities. Most of the world’s foreign currency debt is denominated in US dollars and very little in RMB.
These observations strongly challenge the narrative that the dollar is declining and that the RMB will replace it in the international economy. Many of China’s largest trading partners, such as Hong Kong and Saudi Arabia, continue to operate on a de facto dollar standard. The RMB has gained the greatest appeal from countries, such as Iran, which have strong geopolitical reasons for abandoning the dollar.
With the escalation of Western sanctions against Russia, many countries in the southern hemisphere have expressed a desire to do so reduce their dollar dependence. Not least was the revelation that Saudi Arabia and Brazil will use the RMB for bilateral trade with China. In both cases, China has significant monopsony power as it is the largest importer of hydrocarbons, soybean products and iron ore.
Despite the speculation, China’s progress seems limited. According to SWIFT data, RMB transactions accounted for less than 1.5% in December 2022 – slightly more than Australian dollar transactions and less than Swiss franc transactions. This puts RMB at a distant 7th place. The US dollar accounts for almost 48% of the total.
There are two reasons why the small market share of the RMB in SWIFT cross-border payments is not a fair reflection of the use of the RMB in commerce. First, not all cross-border transactions use SWIFT. estimates by ANZ’s Chinese research team suggest that about 20% of transactions settled with China’s own CIPS system do not use SWIFT.
Second, the total size of the cross-border payments market — about $170 trillion a year — is about eight times the size of global goods exports at $22 trillion.
If one assumes that the vast majority of international RMB usage is trade-related and non-asset-related – which seems reasonable given the low foreign participation rate in RMB-denominated asset markets and China’s dollar-orientation when it comes to their foreign assets – it could be that about 5 -7% of world trade is already denominated in RMB, although such estimates should be treated with caution. CIPS itself saw a 75% growth in settlement volume to around 80 trillion RMB or US$13 trillion in 2021.
Some may interpret this level of RMB usage as disappointing. But if an underlying goal of RMB internationalization is to protect China from possible Western sanctions, while providing sanctioned countries with a temporary solution and to provide efficiency gains in bilateral trade, then it is very satisfying from a Chinese perspective.
The US has extended sanctions against Russia to countries that support or sell their military. Image: Facebook
The return of Russian oil exports to above 2019 pre-war levels shows that sanctions, while backed by countries representing more than half of the world’s GDP, have lost their effectiveness, even as the US dollar remains hegemonic.
The ability to remove selected institutions from the SWIFT system is a powerful tool of economic statesmanship. But it should be remembered that trading took place before SWIFT was founded and today it is still possible – albeit more inconvenient and expensive – to trade without SWIFT.
If China is outside the sanctions, an RMB-based financial ecosystem will help facilitate and reduce the costs of circumventing sanctions – as it was, in part, designed to do.
Stewart Paterson is a Research Fellow at the Hinrich Foundation and Head of Economic Risk at Evenstar. This article was originally published by East Asia Forum and has been republished under a Creative Commons license.
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