Yuan Yearnings
De-Dollarization, Beginning of the End? War in Ukraine boosts Chinese yuan, Multi-currency Monetary System, Currency Multipolarity and the Longue Durée, US Federal Reserve is Hard to Predict
UPDATE: The dollar-based international economic order builds on a global monetary system established after the World War II. But today that system is starting to show signs of cracking, and maybe, just maybe, we are seeing the beginning of the end of the dollar era.
Current geopolitical crises may put China’s currency on the next phase of its path to becoming a global currency – and prompt the onset of the decline of the U.S. dollar from its current dominance.
The dollar continues to command the lion’s share of global trade, at around 84% of transactions, while the US share of international trade is much less.
The recent acceleration of de-dollarization - that is, the diminution of the US dollar (USD) in central bank reserve holdings and as a medium of circulation in global trade - and expansion of China’s RMB in central bank reserves and use in cross-border settlements can be understood as the confluence of different temporalities and their rhythms.
We do not know where the Fed will land for two main reasons. It is a central bank that is excessively data-dependent in an unusually fluid economy; and it lacks a solid strategic foundation.
De-Dollarization, Beginning of the End?
By John Gong, Taihe Observer
Let’s face the fact, the world today is dollarized. Most of the world’s trade is settled in US dollars. The dollar is ubiquitously usable and certainly welcome everywhere you travel around the world – even including today’s Russia, which is essentially engaged in a proxy war against the U.S. Most nations’ central banks hold dollar assets as a major part of their foreign exchange reserves. The dollar-based international economic order builds on a global monetary system established after the World War II. But today that system is starting to show signs of cracking, and maybe, just maybe, we are seeing the beginning of the end of the dollar era.
A new multipolar currency system consisting of a few other currencies seems
to be slowly emerging. Aside from the euro, the British pound, the Japanese
yen, China’s RMB yuan is another currency that has seen substantial growth in popularity over the last few years, partly as a result of the Chinese government’s effort to internationalize its currency, and partly due to China’s increasing weight in the global economic system. Here is a snapshot of the current status of RMB’s internationalization level.
First, let’s look at the SWIFT system, which is the world’s predominant banking transaction system, which accounts for an overwhelming majority of all financial transactions every year. The RMB currently is the fifth most used currency worldwide, accounting for nearly 3% of all SWIFT’s payment volume. But it
needs to be pointed out that many transactions do not pass through the SWIFT system at all. There are also other payment system alternatives out there built by China and Russia. So, the SWIFT’s representation of RMB’s worldwide usage is somewhat of an underestimate.
Read more here.
War in Ukraine boosts Chinese yuan
By Tuugi Chuluun (edited)
The Chinese economy’s sheer size and rapid growth are impressive. China maintained one of the highest economic growth rates in the world for more than a quarter of a century, helping lift over 800 million people out of poverty in just a few decades. The country is the largest exporter in the world and the most important trading partner of Japan, Germany, Brazil and many other countries. It has the second-largest economy after the U.S., based on the market exchange rate, and the largest based on purchasing power.
And yet the yuan still lags as a major global currency. However, current geopolitical crises may put China’s currency on the next phase of its path to becoming a global currency – and prompt the onset of the decline of the U.S. dollar from its current dominance.
China has long wanted to make the yuan a global force and has mounted significant efforts to do so in recent years. For example, the Chinese government launched the Cross-Border Interbank Payments System, or CIPS, in 2015 to facilitate cross-border payments in yuan. Three years later, in 2018, it launched the world’s first yuan-denominated crude oil futures contracts to allow exporters to sell oil in yuan.
China has also emerged perhaps as the world’s largest creditor, with the government and state-controlled enterprises extending loans to dozens of developing countries. And China is developing a digital yuan as one of the world’s first central bank digital currencies. Even the trading hours for the yuan were recently extended on the mainland.
Thanks to these efforts, the yuan is now the fifth-most-traded currency in the world. That is a phenomenal rise from its 35th place in 2001. The yuan is also the fifth-most-actively used currency for global payments as of April 2023, up from 30th place in early 2011. However, the yuan’s average trading volume is still less than a 10th of the U.S. dollar’s. Moreover, almost all trading was against the U.S. dollar, with little trading against other currencies.
And when it comes to global payments, the actual share of the yuan is a mere 2.3%, compared with 42.7% for the dollar and 31.7% for the euro. The yuan also constituted less than 3% of the world foreign exchange reserves at the end of 2022, compared with 58% for the dollar and 20% for the euro.
The U.S. dollar has reigned supreme as the dominant global currency for decades – and concern about how that benefits the U.S. and potentially hurts emerging markets is not new. The value of the U.S. dollar appreciated significantly against most other currencies in 2022 as the Federal Reserve hiked interest rates. This had negative consequences for residents of almost any country that borrows in dollars, pays for imports in dollars, or buys wheat, oil or other commodities priced in dollars, as these transactions became more expensive.
After Russia invaded Ukraine in early 2022, the U.S. and its Western allies put sanctions on Russia, including cutting Russia’s access to the global dollar-based payments system known as the Society for Worldwide Interbank Financial Telecommunication, or SWIFT. That clearly displayed how the dollar can be weaponized.
With Russia largely cut off from international financial markets, it stepped up its trade with China. Russia began receiving payments for coal and gas in yuan, and Moscow increased the yuan holdings in its foreign currency reserves. Russian companies like Rosneft issued bonds denominated in yuan. According to Bloomberg, the yuan is now the most-traded currency in Russia.
Other countries took notice of Russia’s increasing use of the yuan and saw an opportunity to decrease their own dependency on the dollar. Bangladesh is now paying Russia in yuan for the construction of a nuclear power station. France is accepting payment in yuan for liquefied natural gas bought from China’s state-owned oil company. A Brazilian bank controlled by a Chinese state bank is becoming the first Latin American bank to participate directly in China’s payments system, CIPS. Iraq wants to pay for imports from China in yuan, and even Tesco, the British retailer, wants to pay for its Chinese imported goods in yuan.
The combined dollar amount of these transactions is still relatively small, but the shift to yuan is significant. China keeps a tight grip on money coming in and out of the country. Such capital controls and limited transparency in Chinese financial markets mean China still lacks the deep and free financial markets that are required to make the yuan a major global currency.
For the yuan to achieve a truly global standing, it needs to be freely available for cross-border investment and not just serve as a payment medium to accommodate trade. However, the war in Ukraine may have just made it feasible for the yuan to eventually join the ranks of the dollar and the euro – even if the volume isn’t there yet. And any U.S. policy decisions that weaken the reputation and strength of U.S. institutions – such as the recent drama over raising the debt ceiling, which brought the government to the brink of default – will accelerate the rise of the yuan and decline of the dollar.
Read more here.
Multi-currency Monetary System
By Hamid L. Shariff - Taihe Observer
The dollar’s dominance, despite the move away from the gold standard, has persisted since the Bretton Woods Agreement in 1944. It continues to command the lion’s share of global trade, at around 84% of transactions, while the US share of international trade is much less. As a store of value, it also dominates with 58.36% of all central bank reserves held in dollars.
Economists who study reserve currencies tell us that one key ingredient for the making of an international reserve currency is the requirement for strict rule of law. Enforceability of contracts, checks on arbitrary use of power, and democratic accountability through the electorate supposedly provide global confidence that the government of the issuing country will behave responsibly, not abuse its power to artificially manipulate the value of the currency (the big fear being devaluation through fiat or inflationary policies) or confiscate assets held in its currency. However, the regulatory failures leading to the Global Financial Crisis, “the U.S. first” approach toeconomic policy and monetary choices by the Federal Reserve, and more significantly, the increasing use of unilateral sanctions by the U.S. - in what a former official of the US Treasury Department’s Office of Foreign Assets Control (OFAC) describes as its “hidden war” - have shaken the confidence of countries around the world in the durability of the US dollar.
Thus, for most countries, the search for alternatives to the dollar is a natural and understandable demand. Indeed, when the chips are down and alternatives are available, even countries allied with the U.S. will support the success of substitutes. As such, the shift to a multi-currency world portends greater economic stability and fairer competition.
Read more here.
Currency Multipolarity
and the Longue Durée
By Warwick Powell, Taihe Observer
French historian Fernand Braudel framed histories, in part, as the interplay of multiple temporalities and their respective rhythms. He considered événements as short-term events that punctuate medium term conjunctures, and which are set against what he called the longue durée. The recent acceleration of de-dollarization - that is, the diminution of the US dollar (USD) in central bank reserve holdings and as a medium of circulation in global trade - and expansion of China’s RMB in central bank reserves and use in cross-border settlements can be understood as the confluence of different temporalities and their rhythms.
Today, the world is de-dollarizing faster than over the past 30 years. However, it isn’t moving from one state dominated by a single national currency to another state currency. The USD is not giving way to the RMB; the RMB is not trying to “dethrone the dollar.” Rather, the transformation is qualitative: a new architecture is emerging, that is more multipolar than has been the case for the past 70 years or so, in which multilateral trade will be settled by a myriad of national currencies, and possibly in due course with a new non-national trade settlement currency. The new “money architecture” is less likely to embody the idea of money as a reserve asset, which underpinned the Bretton Woods settlement. Instead, with an emphasis on enabling intensified cross-border trade, it is likely that a non- national trade settlement currency, as a measure of multilateral clearing of current accounts in the form of a currency unit, will emerge. The new monetary architecture is, therefore, likely to deprive money of the character of a global reserve asset.
The development of digital currencies is an important precondition for the design and implementation of efficient settlements and clearing in conditions of multipolarity. The ability for digital currencies and wallets to support near real-time cross-border transaction settlements was tested in late 2021, and cross-border use of the digital RMB continues to expand as part of the phased test-rollout of China’s digital currency. China is at the forefront of the design and development of digital technologies, which will undergird the emergent transnational architecture. But a digital currency is only one half of the equation; money - as a means of payment - is only meaningful in the context of continuous circuits of capital accumulation and transformation, so that exchange must always involve a counterpart. This implies the need to develop a synchronized architecture that can support the capture, storage and dissemination of information about the real economy that can deliver data instantaneously as the counterpart to money flows. Blockchains “with Chinese characteristics” are the technical bedrock for this kind of global digital supply chain architecture.
Read more here.
US Federal Reserve is Hard to Predict
By Mohamed A. El-Erian, Project Syndicate
One might think that predicting the US Federal Reserve’s next policy moves would become easier now that it has already hiked interest rates ten consecutive times, for a total of five percentage points. Not so fast: I suspect that few, if any know for sure what the Fed will do at its June 13-14 meeting – not even the Fed itself.
Over the past two weeks, officials at the world’s most powerful and influential central bank have signaled a range of possible actions, from hiking rates again to “pausing” or “skipping” this round and resuming the tightening process in July. One Fed official has even hinted that it would have been better for the institution not to hike at its last meeting, in May.
We do not know where the Fed will land for two main reasons. It is a central bank that is excessively data-dependent in an unusually fluid economy; and it lacks a solid strategic foundation.
For this Fed, much will depend on the employment and inflation data that will be released in the days before the policy-setting Federal Open Market Committee (FOMC) meets. As matters stand (in late May), the data will probably lead them to hike rates again. That is not what I would do, given what I believe should be a more secular and strategic approach to monetary policy.
It is tempting to attribute the wide range of views among Fed officials to the fluidity of economic and financial conditions. After all, America’s debt-ceiling saga and banking-system tremors have further complicated an already uncertain outlook for growth and inflation worldwide.
But that explanation is too narrow, and it is unlikely to stand the test of time. The real reason that we have so much policy confusion is that the Fed is relying on an inappropriate policy framework and an outdated inflation target. Both of these problems have been compounded by a raft of errors (in analysis, forecasting, communication, policy measures, regulation, and supervision) over the past two years.
It is now widely agreed that the Fed dug itself a hole when it mishandled the critical initial responses to the return of inflation. Policymakers have been struggling to climb out ever since. Not only did the Fed mischaracterise inflation as “transitory” for most of 2021, despite mounting evidence to the contrary and warnings from prominent economists. It then responded too timidly after Fed Chair Jerome Powell acknowledged, in late November 2021, that “it’s probably a good time to retire that word [‘transitory’] and try to explain more clearly what we mean.”
These two missteps meant that the Fed would have to play massive catch-up, which it did by implementing the most concentrated set of rate hikes in decades. Such a big, sudden tightening generates greater risks to both growth and financial stability. Yet the catch-up process came too late to prevent inflationary pressures from migrating from the goods sector to services and wages. That crucial development has made core inflation (which excludes volatile food and energy prices) more stubborn and less sensitive to rate hikes, further increasing the risk of compounding policy errors.
This sequence also explains why Fed officials seem to be all over the map when it comes to forthcoming policy moves. Having missed a wide-open window for implementing the best possible response, they now find themselves in a quagmire of second-best policymaking, where every option implies a high risk of collateral damage and unintended consequences. Hike again in June, and you increase the risk of tipping the economy into recession and reigniting financial instability. Refrain from hiking, and you risk losing even more credibility (a problem compounded by the Fed’s excessive dependence on backward-looking data for policy moves that act with a lag).
I suspect that if the next round of labor-market and consumer-price data continues to surprise on the strong side, the Fed will announce another rate hike in June. But regardless of what it decides, its top priority now should be to use the next few months to address the structural weaknesses that led to this mess in the first place. That means not only overhauling its monetary-policy framework and internally assessing the suitability of its inflation target, but also addressing its institutional insularity, lack of cognitive diversity, and poor accountability.
Read more here.