It’s been 13 years since China first started promoting the international use of its currency, but the effort has fallen wildly short of expectations. The yuan is still used far less in global transactions than the dollar and euro, and even lags the British pound and Japanese yen.
However, the need to foster global acceptance of the yuan – and decouple the Chinese economy from the dollar-dominated global financial system – has assumed unprecedented urgency in Beijing. Chinese leaders view the country’s exposure to the dollar both as a strategic vulnerability and as a barrier to realizing its Great Power ambitions.
In a widely overlooked shift, Beijing has already started overhauling its approach to RMB internationalization in recent years. Its previous efforts focused on creating ways for foreigners to use the yuan: Now policy makers are intent on giving them a reason to do so.
There’s no guarantee that Beijing’s new approach will be enough to transform the yuan into a global or regional currency — a third pillar alongside the dollar and euro. Even if it ever achieves that goal, it’s unlikely to make meaningful progress in anything less than a decade.
Bringing other countries into China’s economic orbit requires financial integration, which is only possible if they start using its currency.
Nonetheless, the shift in Beijing’s approach comes at an important moment. Doubts about the dollar’s role as the global reserve currency are mounting worldwide thanks to the U.S. government’s chronic indebtedness and the Federal Reserve’s profligate money printing during the COVID crisis. The dollar-dominated global financial system, once viewed as a common good, is increasingly perceived as a walled-garden, with access denied to countries and institutions deemed hostile to U.S. interests.
So while Beijing’s reinvigorated efforts to promote RMB internationalization may yet fall short, they could have an important impact on the way global markets operate at a time when the dollar’s global role is evolving — and potentially eroding.
A NEW SENSE OF URGENCY
A number of factors are driving China’s rediscovered passion for RMB internationalization. For one, Beijing is increasingly frustrated with U.S. stewardship of the global economy which it believes is exercised solely in American interests.
But internationalizing the yuan is not just a question of monetary policy; it is a matter of national security. Beijing worries it could one day be on the receiving end of Washington’s punitive sanctions — like those imposed on Russia after it invaded Ukraine — potentially in response to tensions over Taiwan. The only way to insulate China from dollar weaponization is for the yuan to be an acceptable alternative.
Finally, China’s great power ambitions will be difficult to realize if it remains dependent on the dollar. Bringing other countries into China’s economic orbit requires financial integration, which is only possible if they start using its currency. A globally accepted yuan could bolster China’s claim to represent a viable alternative to the U.S.-led system.
YUAN IN, YUAN OUT
Beijing formally launched RMB internationalization in 2009, allowing foreigners to use the yuan for investment, cross-border trade, savings, and lending. Back then, it seemed inevitable that the yuan would become widely adopted, since China was and is the world’s largest trading nation. But it wasn’t, partly because the dollar is so difficult to dislodge.
Since mid-2017, Beijing has been trying to establish mechanisms that ensure much larger and more sustainable volumes of yuan flow into and out of the Chinese economy, thereby becoming a more commonly used currency around the world.
Boosting yuan inflows has proven easier to achieve. Beijing has massively expanded ways for foreigners to invest in China, for example through stock trading links between the mainland and Hong Kong. It has also removed caps on foreign investment, and is overhauling its capital markets to attract more global savings.
In most cases, it requires that inbound investments be made in yuan sourced from outside of China. That requirement is already reaping benefits. Forcing foreigners to invest using yuan means that even when they come to withdraw their capital — as many have been doing recently — it doesn’t damage China’s foreign exchange position. Increasingly, what enters China’s economy as yuan is leaving as yuan.
The greater challenge has been convincing foreigners to accept yuan as payment, which in turn would expand the amount of Chinese currency circulating overseas. It is still far cheaper and more convenient to use the dollar than any other currency: trade finance in dollars is widely available, and hedging costs are low thanks to an enormous dollar futures market.
If foreigners are to use the yuan more despite the higher costs involved, Beijing must try to change the way global trade functions. To start with, it hopes to use its heft as the world’s largest consumer of most commodities to make the yuan the dominant currency for settling and pricing transactions in everything from oil to iron ore — as well as renewable and low-carbon technologies.
…the more firmly Beijing sticks to its current strategy for the yuan, the more it will benefit from the world’s mounting disillusionment with the greenback.
Beijing also wants to establish the yuan as the anchor of an Asian trade bloc. Asian supply chains typically now transact in dollars because the U.S. is the main consumer of the end products to which they contribute. Changing that will require China to consume more of what Asia produces, not as a processor but as an end user. Free trade deals will help draw Asian economies closer to China — a key pillar of Beijing’s approach — but only once a more demand-driven Chinese economy makes the yuan more appealing.
Cross-border e-commerce is another major part of the strategy. Traditionally, Chinese firms have paid in dollars for imports, but in cross-border e-commerce transactions buyers typically pay in their own currency. Greater use of cross-border e-commerce platforms by Chinese consumers and firms – should result in more yuan flowing out of China to pay for imports.
WHAT IS TO BE DONE?
Plenty of barriers still stand in the way of the yuan achieving a sustainable international role any time soon — including the outlook for the Chinese economy, the Communist Party’s tendency to meddle in markets, and Beijing’s track record of punishing trading partners over relatively minor political disagreements.
However, as parts of the world grow increasingly disillusioned with America’s leadership, Beijing’s willingness to provide an alternative should be taken seriously. While the U.S. shouldn’t necessarily strive to prevent the yuan’s internationalization, it should ensure that those nations it wants to keep within the dollar’s walled garden willingly stay there, and don’t flirt with the yuan alternative.
Right now, for example, the dollar’s global strength is putting many economies under pressure. To lessen the burden of being part of the dollar order, the U.S. should consider extending the currency swap agreements it currently has with only its closest partners to more nations.
Regardless of the yuan’s fate, the reforms that Beijing is pursuing will have a significant impact on the way China’s economy works, and its engagement with the rest of the world. The dollar may prove hard to budge for a while yet. But the more firmly Beijing sticks to its current strategy for the yuan, the more it will benefit from the world’s mounting disillusionment with the greenback.
Click here to read Dinny McMahon’s cover story on Dalian Wanda Group.
Diana Choyleva is a leading expert on China’s economy and politics, and she is Chief Economist at Enodo Economics, an independent macroeconomic and political forecasting company she set up in 2016 to untangle complexity, challenge the consensus, and give pointers to the future by making sense of today. @choyleva
Dinny McMahon, author of China’s Great Wall of Debt: Shadow Banks, Ghost Cities, Massive Loans, and the End of the Chinese Miracle, spent 10 years as a financial journalist in China before moving to the US where he has worked at think tanks researching China’s economy. @DinnyMcMahon