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Is China Capable of Giving Up Dollar?

© AFP 2023 / STRA Chinese bank employee counts 100-yuan notes and US dollar bills at a bank counter in Nantong in China's eastern Jiangsu province on August 28, 2019
A Chinese bank employee counts 100-yuan notes and US dollar bills at a bank counter in Nantong in China's eastern Jiangsu province on August 28, 2019 - Sputnik International
As trade and political tensions escalate between China and the US, there are increasing calls in China to reduce dependence on the dollar.

Washington is threatening to impose secondary sanctions on Chinese financial institutions servicing people on the US sanctions list and considering delisting Chinese companies from US exchanges.

Meanwhile, China has been providing for the growth in demand for the American currency for many years, and financial wars are now disadvantageous to any country, experts say.

As Michael Howell, head of CrossBorder Capital research group writes in his column to the FT, foreign governments sold $500 billion worth of US government bonds in the second quarter, with China dropping a third of all securities.

Since its accession to the WTO, China has pushed up the demand for the dollar and thus reduced the cost of borrowing for the United States. At the moment, China remains the largest holder of US Treasury securities - more than $1 trillion.

However, we should not forget that as China abandons dollar financial instruments, demand for US currency will fall, and it will become more and more difficult for the US to finance its budget deficit.

Some Chinese officials in recent weeks have started talking about the need to get rid of dollar dependence as soon as possible and to promote the internationalisation of the yuan.

First, Fang Xinghai, Vice-Chairman of China Securities Regulatory Commission, warned of the danger of China's disconnection from the dollar system and SWIFT international payment network in case of the escalation of tensions between China and the United States.

Then similar concerns were expressed by Guo Shuqing, director of the China Banking and Insurance Regulatory Commission. Finally, Zhou Li, former head of the International Liaison Department of Central Committee of the CPC, also stated the need to get rid of dollar dependence as soon as possible.

The reason for these concerns was the latest actions by the United States. The US Senate approved sanctions for the alleged oppression of Uighurs in Xinjiang as well as for China's adoption of the Hong Kong National Security Law.

For the sanctions to come into effect, they still need to be approved by the US president.

American senators have long called for sanctions against Chinese officials under the Magnitsky Act. But Trump has so far been in no hurry to implement these initiatives because he feared that trade negotiations between the two countries would then come to nought.

However, under the current circumstances of the election race, with the US economy going into a tailspin because of the coronavirus epidemic, the candidates from the two parties seem to have come up with nothing better than to play the Chinese threat card.

Addressing the pressing socio-economic problems in the country in such a short period is hardly possible, so the easiest way is to switch the degree of tension from internal problems to external threats.

This explains the constant US calls to hold China accountable for the global pandemic, calls for new, restrictive listing rules for Chinese companies, and even secondary sanctions for banks and financial institutions that serve individuals allegedly involved in human rights infringements in Xinjiang and the Hong Kong National Security Law.

Sanctions against Chinese financial structures may indeed be painful. The share of the yuan in China's international settlements in 2019 was just over 19%. The dollar and the euro still account for the majority of trade, Chen Fengying, Director of the Institute of World Economics of the China Institute of Contemporary International Relations, told Sputnik.

“According to statistics, settlements in yuan in 2019 accounted for only 19.15% of total Chinese trade settlements. The rest fell on the dollar and the euro. An even bigger problem is the currency reserves. It takes time and concerted efforts to get rid of the dollar. We can see that all the countries of the world facing the hegemony of the dollar are trying to get rid of the dollar dependence but there is no alternative yet. That includes the euro. So, in the short term, I think it might be just a wish. But in the medium and long term, getting rid of dollar dependence should be the ultimate goal”, the Chinese expert said.

In the short term, dollar sanctions against China may hurt the US itself. According to the WTO, 13% of world exports and 11% of world imports – the largest shares in world trade – are accounted for by China.

If the dollar is excluded from the settlements of such volume of transactions, it can create shocks within the US financial system.

At the same time, Russia's experience shows that in case of the introduction of restrictions on access to the American financial system, it is relatively easy to switch to euro settlements. As a result, the US simply seeks to reduce the share of its own currency in international settlements.

Just a few years ago the dollar accounted for more than half of international settlements, and now it only stands at about 40%. At the same time, due to the status of the dollar as the world's main currency, the United States allowed itself to exist for many decades to have a huge budget deficit, which was financed, in fact, by other countries.

Washington is very likely to leave the threat of a financial war with China simply at the level of rhetoric. After all, there is no real alternative to the dollar at the moment, although the American financial system is not devoid of flaws, expert Chen Fengying said.

“The international investment situation is not very good right now. In many regions, deposits have shifted to negative rates. However, the US bond market is still in a positive zone. So, I think it is impossible to give up American debt so far.”

However, due to the impact of quantitative easing and the budget deficit, US government debt is not exactly a reliable tool, the expert says. Objectively speaking, after the 2008 financial crisis, the world was hit by a wave of quantitative easing.

Of course, as Chen Fengying notes, the US was the most supportive of this process, and this threatened the stability and status of the dollar.

“Nevertheless, I think it is not just an American issue. It's a global problem. It's just that the dollar as the dominant currency is being paid more attention. You can say that “all the apples are rotten” but the dollar, among them, is still quite reliable.

If other currencies were just as reliable, we would have already switched to making settlements in them. But, unfortunately, there is no alternative yet. “This is a real problem of the world economy”, he said.

The confrontation between China and the US is increasingly being called the new Cold War. However, unlike the Cold War between the USSR and the US, whose economies were poorly connected, Beijing and Washington are now closely dependent on each other.

Therefore, many US analysts, including Nicholas Lardy of the Peterson Institute for International Economics, believe that the most likely scenario in the near future will be an exchange of tough statements without significant real steps aimed at economic decoupling.

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Judging by market sentiment, American business is not ready for a confrontation with China, and even on the contrary, it aspires to the Chinese market amid worsening political relations between the two countries.

Last year, PayPal became the first foreign company servicing electronic payment services in China. JP Morgan has received permission to transfer its business in China completely under its control.

American Express became the first foreign company to obtain permission to conduct a credit card business in China. And the world rating agencies S&P Global and Fitch enthusiastically took up the Chinese credit rating market.

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