Friday 08 Oct 2021 | 02:32 | SYDNEY
Friday 08 Oct 2021 | 02:32 | SYDNEY

Can Beijing replace the greenback?


Mark Thirlwell

15 July 2009 15:50

My recent research trip concluded with a conference in Beijing, where I spoke at a sub-fora on the changing global environment for foreign investment. But my key take-away from the conference, based as much on the discussion as the formal speeches, was China’s growing focus on the need to reform the international financial order.

It seems East and West have been learning different lessons about the implications of the GFC for the world economy. For many in Washington, the key international problem is the need to deal with global imbalances, and the solution is more domestic demand and more exchange rate flexibility from places like China. 

Beijing takes a different view. Chinese policymakers see the source of most of the crisis in domestic regulatory and supervisory failure in the US. But they are also aware of the challenges posed by global imbalances. Here, however, they assign a key role to the status of the US dollar as the world’s reserve currency and the so-called ‘exorbitant privilege’ this has granted.

Fixing the problem implies a need to rethink the role of the greenback.  Of course, in practice, the fact that Beijing is worried about its large US dollar exposure is closely linked to this analysis.

Reform of the international financial order by, for example, granting a greater role to Special Drawing Rights (SDR) along the lines proposed earlier this year by PBOC Governor Zhou Xiaochuan has since received some distinguished support. There was also some approval for the idea of dethroning the greenback at the inaugural BRIC summit. And China continues to criticise the dollar’s leading role, most recently at the G8 meeting. 

Still, the barriers to the SDR replacing the dollar are substantial. So in the near-term, the rise of another national currency to provide central banks and others with a competitive alternative – with the euro the leading candidate – looks to be the most likely scenario. Even then, it should be said that, to date, the GFC has not been particularly kind to the euro’s pretensions as an alternative to the dollar.

What of the yuan as an alternative to both the greenback and the euro? While there is a fairly broad agreement that any such Chinese currency challenge is still a long way off – pending China developing much deeper national financial markets and embracing full currency convertibility – nevertheless, the past year has seen China take a series of baby steps towards the internationalisation of the yuan. Specifically:

  • On 8 April this year, China’s State Council approved a pilot yuan settlement project linking five mainland cities — Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan — to Hong Kong and Macau. The PBOC launched the program on 2 July and on 6 July three Shanghai-based firms completed the first commercial yuan cross-border transactions.
  • Beginning in December last year, China has signed a series of bilateral swap agreements aimed at supporting trade and investment flows. Six deals have been inked so far: Korea, Hong Kong, Malaysia, Belarus, Indonesia and Argentina. China is also in discussions with Brazil, although the final deal may not take the form of a swap agreement, and Malaysia has also publicly flirted with the idea of moving away from the greenback in bilateral trade with China.
  • In May this year, China announced that two foreign commercial banks would be allowed to sell yuan-denominated bonds to foreign investors.

Beijing’s strategy is now generally seen to be one of building on China’s already important role in international trade and its rising importance in foreign investment to gradually encourage a rising proportion of its international transactions to be denominated in yuan. 

Sceptics have been quick to point out that the absence of convertibility will strictly limit the attractiveness of the yuan to exporters and hence act as a significant constraint on these initiatives. Even so, recent developments make it clear that the yuan’s long march to the status of global currency is underway.

Photo by Flickr user phil dokas, used under a Creative Commons license.