Growing pressure to de-dollarize: China wants to diversify foreign exchange reserves

The detonation of the "financial nuclear bomb" against Russia, i.e. the SWIFT exclusion and the freezing of dollar assets abroad, has also set alarm bells ringing in China. Beijing wants to push ahead with de-dollarization.

Chinese financial experts, Growing pressure to de-dollarize: China wants to diversify foreign exchange reserves

RIO DE JANEIRO, BRAZIL – For several years now, Chinese financial experts have been warning against relying too much on the U.S. dollar (and specifically on U.S. government bonds) for foreign exchange reserves.

The Chinese side is particularly critical of the fact that U.S. bonds are actually a minus trade. This is because the inflation rate is higher than the interest rates and also in terms of exchange rates, the U.S. government securities are not really profitable for the Chinese central bank.

Now, with inflation skyrocketing in the United States while interest rates on the securities remain modest, it doesn’t get any better.

But that is not all. Western sanctions against Russia for its military operation in Ukraine and the impact of U.S. interest rate hikes have further fueled discussion in China about how to reduce dependence on the dollar system and establish the yuan as a strong, internationally traded reserve currency.

Calls for a more independent financial system in China come amid difficult relations with the West, following the outbreak of the U.S.-China trade war in 2018, the outbreak of the coronavirus, and tensions over geopolitical issues from Hong Kong to Taiwan.

As concerns grow in China about its dependence on the U.S. dollar system, some government advisers are urging authorities to overhaul the exchange rate system and make the yuan an anchor currency, especially for the Asian region.

This could be done, for example, by Beijing entering into trade agreements with Asian, Latin American, and BRICS countries that are denominated in yuan and in the respective national currencies.

The respective countries could then also increasingly include yuan in the balance sheets of their central banks and thus diversify their currency reserves as well. This would strengthen the Chinese currency and, moreover, the other Asian and Latin American currencies as well.

Overall, there is growing pressure within the BRICS group of countries to de-dollarize as well, especially driven by Russia and China.

Despite strict capital controls, the Chinese economy is vulnerable to international financial turmoil. The 2008 global financial crisis led to the loss of 20 million factory jobs, and the yuan exchange rate underwent huge fluctuations between 2015 and 2017 due to the Federal Reserve’s tightening policy and a one-time devaluation of the yuan.

Recently, Chinese authorities have also complained about the side effects of the unprecedented money printing by the U.S. to combat the effects of the covid lockdowns. Indeed, sooner or later, this will have an extremely negative impact on the stability of the U.S. dollar, and with it the vast amounts of dollar reserves held by China.

But who will then buy up all those U.S. government bonds?

WILL BRICS COUNTRIES STAND TOGETHER?

Chinese experts have urged BRICS countries, namely Brazil, Russia, India, China, and South Africa, to counter the dollar’s global dominance which is now being abused by the United States government, a report has said. According to experts from the Bank of China, BRICS countries can achieve this by enhancing trade ties and limiting their reliance on a financial system in which the U.S. dollar dominates.

As explained in a Global Times report, the call by the experts was made just before the foreign ministers from the five countries were scheduled to hold a virtual meeting on May 19. At the meeting, the foreign ministers were expected to discuss enhancing solidarity, building consensus, as well as giving emerging markets a greater voice in global governance.

In making the case against BRICS countries’ continued dependence on the U.S.-dominated financial system, one of the experts, Cao Yuanzheng, the chairman of BOC International Research, claimed the United States only prioritizes its domestic needs and is less concerned about the potential consequences of its policies.

US DOLLAR NEUTRALITY

The expert added that the recent sanctioning of Russia, as well as the United States government’s freezing of the former’s forex and gold reserves, means the U.S. dollar is no longer a neutral currency.

Meanwhile, the report implied China’s yuan currency, which is popular in countries and regions along routes of the Belt and Road Initiative, can be an alternative to the dollar. Therefore, an agreement between BRICS countries could potentially result in the increased use of the yuan in certain regions, the report said.

However, other experts interviewed by Global Times warned that reducing the U.S. dollar’s dominance will take time. Similar sentiments were recently expressed by the former governor of China’s central bank, Zhou Xiaochuan.

Xiaochuan has previously warned that reducing the dollar’s dominance will also depend on whether businesses and the public are willing to suddenly abandon a currency they have been using for a long time.

Tian Yun, the former vice director of the Beijing Economic Operation Association, suggested the yuan’s chances of taking the U.S. dollar’s position as the main settlement currency depends on other countries’ confidence in China’s progress.

Still, another expert, Zhou Maohua, a macroeconomic analyst at Everbright Bank, spoke of the Chinese currency’s rising role in global payments, settlements, and foreign exchange reserves over the long term.