Does the rise of the Yuan mean the death of the Dollar?

A trend in the global economy towards dedollarization is prompting debates about financial decoupling as a pathway for growing multipolarity. Dedollarization is leading to new avenues for challenging US global hegemony post-1945 by reducing reliance on US financial investment and allowing for trading in national currencies. While many poorer nations have been unable to challenge US dollar hegemony, globalization has made room for the rise of the Renminbi as a regional and international trading currency. While China is unlikely engage in typical US tactics for becoming the world’s “safe haven” currency, the rise of alternative currencies for trading and in particular the RMB is creating new pathways for multipolarity in the global trading system. However, in order to understand why currency trading currently operates in the way that it does, its important to establish how the world got to this point.

Since the 1945 Bretton Woods Conference, the United States has experienced dollar hegemony through a series of reforms that have eventually turned the dollar into a global reserve currency. The Bretton Woods agreement left the United States as the newly crowned world’s official reserve currency. The Vietnam war deficit spending and the Great Society domestic programs created an environment where the US market would be flooded with money. Even though, the US dollar lost its gold-backing in 1971, it’s strength remained and in fact remained throughout some of the most turbulent periods in financial history. Some economists in the lead up to and during the 2011 financial crisis predicted that the dollar would take a sharp tumble, however, one economist Eswar Prasad a former IMF analyst devised a theory in his book The Dollar Trap on why this may not be the case. From September 2008 to December 2008, the US economy had net capital inflows of half a trillion dollars from private investors and prices of US treasuries securities increased meaning that interest rates remained low. Prasad theorized that financial crisis or instability, even when it happens in the US domestic market, “raises the demand for safe financial assets that…can be easily converted to other currencies, that are liquid”. The US is like no other economy in the size and availability of its debt markets both in turns of the volume available for trading and the turnover. Finally, the establishment of global institutions, such as the World Trade Organization that rely upon the US as a gold currency, Prasad argues is one of the primary reasons for its continued strength today.

Dedollarization, to the extent that it occurs in the modern economy is most often prompted by US sanctions and most economies, even those who consciously undertake dedollarization programs, still do not completely abandon the dollar. Russia as a more successful example of an economy that undertook a program to carry out dedollarization via the Central Bank successfully now carries out 72% of settlements in the national currency and since 2018 has dumped 84% of its US Treasury holdings. However, many other countries that have also undertaken schemes to carry out dedollarization still hold large quantities of US treasury holdings. Argentina as an example of this underwent dedollarization as a response to a severe financial crisis that was leading to people moving foreign exchange reserves into US dollars, the government initiated a policy to convert foreign currency deposits into the Peso. Other nations such as Brazil, Chile, Columbia, Venezuela, Israel, Poland, Armenia, Estonia, Lithuania, Nicaragua, Peru, Laos, Bolivia, Honduras, Lebanon, Vietnam, Malaysia, Phillipines and Mexico all have undertaken similar schemes as a “macroeconomic stabilization measure.” In some cases, such dedollarization programs have been done successfully without any transitional crisis’ however the most obvious instances being Mexico and Pakistan underwent a fast dedollarization process that lead to “macroeconomic costs.” Similarly, Bolivia and Peru experienced a similar fate that lead to only short-term dedollarization as the economic shock of the process lead to them seeking to re-dollarize. In the available literature, much of the focus on these case studies appears to point to successful and unsuccessful policy directives for carrying out the dedollarization process however what is less focused on is whether the nations that have achieved sustained dedollarization have since been moving towards a path of more autonomous and/ or quicker development than those who havent. The IMF working paper research on the above listed countries seems to uphold Prasad’s argument in the respect that the majority of countries across the globe even today still remain highly dollarized however there are competing views on what sustained dedollarization can mean for global trade.

China, alongside its own periphery nations, is on track to becoming one of the biggest economies in the globe that is sustaining trade relations with poorer countries and much has changed in this sphere since Prasad’s book was published in 2015. Numerous nations, some that are subject to US sanctions, are seeking to escape the dollar in bilateral trade. The most recent example of this is China’s trade agreement with Pakistan where all future trade will switch from the dollar to the yuan and Pakistan’s central bank has now allowed for commercial banks to receive deposits and provide trade loans in hard currency yuan. In Hong Kong, the yuan is now the second largest currency exchange and others are joining in maintaining significant quantities of RMB in their exchange stores including Nepal, Cambodia, Sri Lanka and Bangladesh. Iran has also completely ditched the dollar in its trade with Russia in Turkey and as a major oil exporter poses a threat to one of the basis of dollar’s dominance. But of course, for countries like Russia, Iran, Venezuela, Cuba, Zimbabwe, Sudan and the Democratic Republic of Congo one of the primary motivations is that sanctions force these nations to either adhere to US demands or to be cut off from the world economy — giving the US a certain level of power in imposing political will on smaller economies. Since Prasad’s book was published there has been the important emergence of what is now being dubbed the “petro-yuan” which China is establishing by asking oil-exporting nations such as Saudi Arabia, Iran and Angola to receive yuans for their oil. One of the major incentives for using the Yuan over the dollar is China’s increasingly more well-established credibility in the international market and its own incentivization strategies in the form of aid or investment projects via the One Belt One Road. But does this really lead to multipolarity or a true challenge to dollar hegemony?

The prevailing consensus in the literature on the question of dollar hegemony is that the US dollar will maintain its success in the future however Prasad disagrees with exactly why. The predominant argument in the mainstream literature is that, although China is seeking to achieve a greater amount of reserve currency globally and is moving away from the dollar in global trade, that most Global South nations’ currencies are still heavily pegged against the dollar including China themselves. As one IMF working paper from 2009 summarizes “most other countries remain highly dollarized at end-2007 with the ratio of FCD’s still in excess of 30 percent.” Another IMF working paper draws the conclusion that there are drawbacks to dedollarization that disincentivizes countries taking up this challenge individually such as that it requires such as that it “limits the effectiveness of monetary policy, dollarized countries lose part or all of their seignorage, dollarization reduces the efficiency of payment and that partial dollarization increases balance sheet risks.” The views outlined in the paper are generally inline with an orthodox neoliberal consensus on the strength of the dollar however in practical application they do not discourage the dedollarization process entirely. The recommendation for overcoming some of the above listed challenges in these working papers is usually to follow a heavily marketized process and even purport that one of the reasons for Global South nations to be moving away from the dollar was its instability in the wake of 2011 financial crisis. Prasad offers up a potentially more heterodox view on the questions of both whether its possible for a Global South nation to successfully carry out dedollarization via swift government reform but also on whether US treasuries become an attractive target in the context of financial crisis offering up a potentially more convincing argument for the strength of the dollar respectively.

Prasad believes that while countries like China certainly have the ability to become a reserve currency where they lose out is in the ability to be what he dubs a “safe haven currency.” Where the mainstream view is one of speculation about the fact that major world players like China and Russia are looking to move away from America as a result of its instability and that in the case of some economists he rebuffs in his own book such as Jim Rogers, the co-founder of the Quantum Fund stating “If [Federal Reserve Chairman] Ben Bernanke starts running those printing presses even faster than he’s already doing, we are going to have a serious recession. The dollar’s going to collapse, the bond market’s going to collapse.” Prasad offers up that instability is exactly the reason why world players buy up US treasury securities which is something that only the US has thus far been able to provide by running up massive trade deficits. He acknowledges that “US debt markets…remain unrivaled in terms of both depth and liquidity.” The US has set up a cyclical motion locking both itself and, in particular, Global South nations into a setting of mutual interdependence by borrowing “from the rest of the world…and the dollars status has allowed (the US) to reduce its debt burden to other countries simply by printing more dollars.” Much like other former analysts he acknowledges China’s strong performance over the past few decades and in turn posits that China does very much has the ability to at the very least compete with the dollar as a major world reserve currency given that the “government has…taken a number of steps to increase the international use of the renminbi.” Aptly, however, Prasad points out that China’s regime of a certain level of export-oriented industrialization means that China must hedge against their own currency appreciation explaining that “by limiting the flow of money in either direction, capital account restrictions help control the value of the renminbi.”

What Prasad ignores and which simply may be a product of his book having been written in 2005 is that, where China necessarily must control against a certain level of appreciation in order for their exports to remain sufficiently competitive, in 2020, China’s macroeconomic reforms are moving the nation towards a consumption-based market. For obvious reasons, post the announcement of an all-out trade war and even slightly prior China has been moving away from reliance on the export of goods to the US. As Spantig notes “the high Chinese demand for US government bonds has the long-term effect of encouraging the US Fed to keep interest rates low.” However, what happens when China’s savings rate begins to decline as they increase consumption? The Covid-19 crisis meant that “domestic savings and the Fed balanced sheet financed the flood of Treasury debt issuance” unlike the last financial crisis and China’s more recent shift towards a consumption economy can mean that the they are less reliant on US treasuries as a hedge against RMB appreciation. So, while the heterodox view presented by Prasad offers an explanation for why neoliberal economists were wrong about the last financial crisis and why dollar hegemony remains to this day, he may be ignoring the degree to which global south nations, due to geopolitical concerns and a drastic shift in China’s long-term priorities may in fact lead to the decline of the dollar in global markets.

China is initiating a strong set of policies not just to shift towards a consumption economy but to strengthen their international legitimacy — an important factor in their establishment as a reserve currency globally. For example, in Hong Kong, where there is now significant domestic trade settlements in RMB, they allow for RMB qualified institutional investors to make investments in the domestic securities market with a threshold of up to RMB 20bn. So, Prasad may be correct. China is unlikely to repeat the mistakes of the US by becoming a safe haven currency via excessive spending and their Central Bank will likely remain heavily regulated. However, if China moves more towards consumption, the US will have absolutely no choice but to continue to grow their wealth via significant investment in targeted industries (doesn’t seem likely) or to become the inverse mirror of China — that being to experience a hit in the dollar in order to become a competitive export-oriented nation. Either way, the US is backed into a metaphorical corner where old growth tactics will no longer and this puts the US establishments current frenzy around international trade into a much more clearly dire context for the future of US hegemony.

A communist, and anti imperialist