Marc Chandler
The financial shocks that keep hitting the dollar haven’t shaken its role in the world economy. The reasons matter. The dollar may not be eternal. But it won’t be China that knocks it down.
The confiscation of Russia’s central bank reserves and potential plans to use them to help Ukraine were thought to cut the dollar’s attractiveness. The U.S.’s increasing reliance on sanctions and weaponizing access to the dollar have escalated the talk of alternatives. The banking failures in the U.S. renewed questions about its susceptibility to destabilizing financial crises. Meanwhile, China’s ties with Saudi Arabia have led to speculation of a petro-yuan that displaces the petrodollar.
There are two ways the dollar could lose its place in the world economy: encroachment, in which another currency supplants the dollar, as the dollar replaced sterling a century ago, or abdication, where the U.S. pursues policies that shrink back from the global role it previously sought. Concerns about China fall into the encroachment camp, but little substance exists. The more significant threat is self-immolation. Those who see the dollar’s role as an exorbitant burden, not a privilege, want to abandon it. That would be a type of financial disarmament in the great game of international influence that extends beyond prices and quantities.
China may be Saudi Arabia’s biggest customer, but there’s no sign that Saudi Arabia will price oil in yuan. It makes no sense on several levels, including that the Saudi riyal is pegged to the dollar. When the Federal Reserve changes interest rates, the Saudi Arabia Monetary Authority and several other Middle Eastern countries typically quickly match the move.
The Chinese yuan is simply not convertible. It isn’t a question of technology but policy. China’s foreign-exchange rate is closely managed and purposefully opaque. Its capital markets are developing but aren’t sufficiently transparent. Including the yuan in the International Monetary Fund Special Drawing Rights in 2015 was supposed to spark growth in yuan reserves, but as of the end of the third quarter of 2022, the yuan’s share of international reserves was about 2.75%. The yuan’s share of Swift transactions briefly rose above 3% early last year, but by February 2023, its share had slumped to about 2.2%.
Listening to some U.S. commentary about a rising yuan, you’d get the sense that America is being victimized. But China has hardly abandoned the dollar. The Asian Infrastructure Investment Bank, once considered a challenge to the World Bank, has struck a cooperative accord with it. The AIIB takes U.S. dollar subscriptions and has been joined by U.S. allies, including the United Kingdom, Germany, Australia, and Israel.
Even China’s Belt and Road Initiative, seen as a power projection exercise, cannot be divorced from the dollar. Initially, China made yuan loans, but recipients quickly swapped into dollars. So now, Chinese banks finance BRI loans with dollars.
Moreover, focusing on how oil transactions are denominated confuses the key to the dollar’s role in the world economy. It also misunderstands what has happened over the past 40 years. Put simply, if crudely, the market for money outstrips the market for goods by magnitudes.
The Bank for International Settlements estimates that the daily turnover in the foreign-exchange market is $7.5 trillion daily. Global trade for all of last year was about $32 trillion. The dollar is on one side of 88% of currency trades, little changed from 1989 (when the dollar was one part of 90% of currency trades). China may be the most important trade partner for more countries than the U.S., but the dollar’s role remains paramount.
The pricing of oil and many other commodities in dollars isn’t the cause of the greenback’s role in the world economy but a reflection of it. The U.S. capital markets’ depth, breadth, and transparency are its bedrock and are overlaid by its military dominance and legal system.
Nor is the diversification of reserves toward the euro, sterling, yen, or Canadian and Australian dollars a threat to the dollar. The financial sanctions on Russia were imposed broadly, if not universally, and those countries and regions are deeply entrenched in the dollar-centric world. Also, as technology has improved and reduced the barriers to entry, several new payment systems have arisen over the past couple of years. They are small and fragmented.
U.S. sanctions have created niche opportunities for unlikely alternatives, including the United Arab Emirates’ dirham, which India has begun using to pay for Russian oil. India, not China, has emerged as the largest buyer of Russian oil, and New Delhi wants to avoid the yuan, given the rivalry.
Yet the yuan’s sphere of influence is poised to expand. While the North Atlantic Treaty Organization drove eastward after the Soviet Union collapsed, China’s BRI extended its reach into the soft underbelly of central Asia. And now it seems that Russia will be in the yuan’s orbit as a cost of Putin’s Ukraine folly. Chinese companies have moved into the vacuum left by the withdrawal of Western companies. At best, a yuan bloc is in the early stages of forming to include Russia, North Korea, and Iran. They didn’t quit the dollar bloc but were fired from it. The fate of the dollar lies in Washington, not Beijing.
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