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China and De-dollarization – Part 1 – Overview

De-dollarization

Part 1 - Overview

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The so-called “de-dollarization” phenomenon is really a reflection of China’s ascendancy to superpower status – there can be no question it is the main driver behind the emergence of increasingly powerful inter-regional economic organizations, innovative trade agreements that circumvent the USD’s role as the world’s primary currency for trade settlement, and conceivably, the demise of the USD as the world’s de facto reserve currency. In this Part 1, we summarize the key factors that might trigger a future change in currency usage by China and its trading partners.
SINOLOGIX Staff
www.sinologix.io
info@sinologix.io
2023-04-06
CHINA AND DE-DOLLARIZATION - PART 01

Overview

The de-dollarization phenomenon is really a reflection of China’s ascendancy to a superpower status – economically, politically, and militarily. While many countries in the so-called Global South have long supported de-dollarization in favor of trade settlement in local currencies, there can be no question that China is the main driver for this trend – without its active support, it’s unlikely that a de-dollarization movement would have achieved the necessary critical mass to be considered a real or potential threat to the USD.

But is the world economy ready for a pivot to alternative currencies, at least to a degree that the role of the USD as the world’s de facto reserve currency is at risk? We would argue that the trend has begun, but any transition to the Chinese renminbi (or any other local currency) has considerable hurdles that must be overcome before it will displace the dollar in a meaningful way. A far more likely scenario, however, is that the Global South becomes sufficiently independent that sanctions, wherever they may be applied to enforce US foreign policy, may be weakened to the point they are no longer effective.

In this Part 1 of a 4-part series, we summarize the key factors that might trigger a future change in currency usage by China and its trading partners.

In Part 2 (see link below), we examine the structure and role of emerging regional organizations that seek to break free of what they perceive to be US hegemony, especially as it is exhibited in the global financial system.

NOTE TO READER – for those not familiar with Chinese currency terms, renminbi is the official name of China’s currency, and yuan is a unit of that currency. We use the former term in all our reports

GDP - G7 vs BRICS - SCO (2022)

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GDP - G7 vs BRICS - SCO (2022)

Data Source – World Bank

The chart above combines GDP for the BRICS and the SCO, as there’s substantial overlap in their membership. The additional candidates are shown in the BRICS+ and SCO+ segment and account for an additional 6.4%. Collectively, the current BRICS, SCO and candidates account for 32.7% of the world’s total GDP.

Key Factors

De-dollarization is a complex issue – our interest in this analysis is understanding the role of three separate, but closely intertwined, sub-topics – the rise of regional organizations that directly challenge the G7 and NATO, trade agreements that introduce alternative currencies and payment systems, and the cascading impact of these two trends on USD and Treasuries holdings outside the US.

Emergence of Inter-Regional Economic Organizations

The rapid expansion of non-G7 organizations made up of Asian, Central Asian, Middle East, African and Latin American countries has launched a profound shift in political and economic power that threatens to upend more than 70 years of US dominance on the world stage. We’re referring to the so-called BRICS+, the Shanghai Cooperation Organization and the Eurasian Economic Union. The significance of the BRICS+ and SCO is their economic footprint – it now accounts for nearly 32% of the world’s GDP and its members are among the fastest growing economies – by 2050, China’s and India’s combined GDP (measured as purchase power parity) is forecasted to reach $165.9 trillion, compared to the projected $39.7 trillion for the US . Furthermore, all three organizations are rapidly incorporating new members and coordinating their respective political and economic agendas. It’s worth noting that this expansion is occurring right on the US’ doorstep – Mexico, Nicaragua, and Argentina have recently expressed interest in joining BRICS.

As shown in the table below, these organizations have substantial overlap in membership. To avoid redundancy in our analysis, we’ve decoupled organization-specific from country-specific policies and actions. For example, although China’s and Russia’s alternatives to the SWIFT payments system will likely affect most, if not all, BRICS, SCO, and EAEU members, they were developed independently of any one organization.

Also, to distinguish between charter members and other countries in the membership pipeline, we use BRICS and SCO to reference current members, and BRICS+ and SCO+.to reference a superset of current and candidate members.

Extended BRICS, SCO Membership

(swipe on column 2 to scroll table)

Data Source – World Bank

Trade Agreements

Numerous trade agreements have been signed and/or proposed to bypass the USD as the de facto currency for trade settlement. This includes one-off agreements between individual countries, such as the March 2023 agreement between China and Brazil to settle trade using the real and renminbi, the March 2023 renminbi-settled energy deal between the UAE and China for 65,000 tons of LNG, and China’s proposal to use renminbi to pay for (at least some of) the 87.5 million tons of oil it imports annually from Saudi Arabia.

To the extent that the countries involved are major suppliers of commodities, the reduction in USD-denominated trade is significant. Perhaps more ominously for the US, China has proposed using baskets of currencies, and the BRICS recently proposed an entirely new currency to replace the USD for regional trade.

In addition to currency implications, these trade agreements also establish new trade routes that enable participants to circumvent US sanctions:

  • The International North–South Transport Corridor (still in its early stages) will connect Russian exporters with Asian markets through Azerbaijan, Iran and India – this transit route bypasses the Suez Canal entirely.
  • The Power of Siberia natural gas pipeline from Russia to China has been operational since October 2019 and will enable Russia to deliver 38 billion cm of natural gas directly to Chinese markets in 2023. In January 2023, the two countries signed an inter-governmental contract that reinforces their commitment to the ruble and renminbi for trade.
  • China’s Belt and Road Initiative (BRI) is a long-term project that commenced in 2013 and is slated for completion by 2049. As it pertains to the issue of de-dollarization, China is working with its BRI partners to create currency swap mechanisms.

Decline in USD US Treasuries Holdings

An increasing trend among BRICS and SCO members is a gradual (or not so gradual) reduction in USD and US Treasuries held as currency reserves. There are two drivers for this – first, a growing distrust of US foreign policy and the consequences of sanctions and/or frozen assets, as happened to Russia and Belarus at the start of the Russian-Ukrainian War. Second, the shift away from the USD to settle international trade has reduced the demand for USD-denominated foreign currency reserves.

The rapid expansion of BRICS and the SCO, as well as successful diplomatic efforts by President Xi Jinping, has had a knock-on effect in BRICS and SCO member countries decisions to pivot away from the USD. And those decisions will eventually have a cascading effect on the demand, or lack thereof, for USD-based foreign currency reserves.

Foreign Holdings of US Debt X Country (2022)

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Foreign Holdings of US Debt X Country (2022)

Data Source – Statista

The chart above only shows the current allocation of US Treasuries by country for 2022. Trend analysis indicating increase/decrease by year will be discussed in subsequent sections for China.

Conclusion

While the entry point for this analysis is the potential for de-dollarization at scale, the trend to a more balanced global financial system is unlikely to result in the demise of the USD in the foreseeable future.  However, there are two important potential consequences of any diversification away from the USD for trade settlement.

First, even a nominal reduction in foreign currency reserves may amplify inflationary pressures on the US Treasury vis-à-vis interest rates. In all candor, we have not evaluated the extent to which domestic buyers of Treasuries will absorb any such reduction in foreign demand. And certainly, there are many other factors that influence this equation. But it’s worth noting that the cost of servicing the US’ $31 trillion debt is already $475 billion – even a minor increase in applicable coupon rates for Treasuries will have a profound effect on government operations.

Second, US foreign policy in the last several decades has increasingly relied on sanctions to coerce governments deemed unfriendly to bend to the will of the US. Those sanctions depend on a tightly integrated global financial system to force countries such as China, Russia, and Iran to comply with US demands. The real risk (to the US) of so-called de-dollarization is that its adversaries are in an increasingly favorable position of being able to circumvent most sanctions. The most conspicuous example of this is the sanctions against Russian oil and gas exports – while there was an initial economic hit (Russian GDP declined by an estimated 2-3% in 2022), export operations have effectively pivoted to eastern markets (Russia’s GDP is now expected to grow in 2023). There is a compelling argument that the sanctions have hurt the EU’s economy as much, if not more, than Russia’s.

These two possible outcomes need to be closely monitored. There is a kind of positive feedback loop at play here, whereby heavy-handed US sanctions for what may be perceived as questionable causes encourage members of the collective Global South to think twice about the extent to which they want to tie their fortunes to the traditional global financial system.

The perception of US hegemony, vis-à-vis military interventions in countries such as Libya, Afghanistan, Iraq, Syria, and Ukraine, non-military interventions in countries such as Iran and Venezuela, as well as the proxy effect of the IMF and its notorious “conditionalities”, has alienated a number of countries who have patiently waited for an opportunity where the collective economic and political power of an alternative to NATO and the G7 would present itself. And with the arrival of President Xi in 2013 and his vision for just such a China-led alternative, that moment seems to have arrived.

Belated Recognition of a Growing Problem

A growing chorus of western media pundits are finally acknowledging what we have been suggesting on this site for some time – that the global balance of economic and political power is shifting in a decidedly Central and East Asian direction. This shift is now dramatic and rapidly gaining momentum, and China is in the driver’s seat.

At the conclusion of the recent Sino-Russian summit in Moscow, President Xi ominously commented to President Putin, 

Change is coming that hasn’t happened in 100 years and we are driving this change together...

Or to borrow from Ernest Hemingway (The Sun Also Rises):

Things change “slowly at first, then all at once”.

NOTES

References and Disclaimers

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Works Cited

Liu, Zongyuan, and Mihaela Papa. “Can BRICS De-Dollarize the Global Financial System?” Cambridge Core, Cambridge University Press, 24 Feb. 2022, https://www.cambridge.org/core/elements/can-brics-dedollarize-the-global-financial-system/0AEF98D2F232072409E9556620AE09B0.

Related Research and Articles

China and De-dollarization – Part 2 – BRICS and SCO

While China is a driving force in the Global South’s pivot away from the USD, the rapid expansion of inter-regional economic organizations made up of Asian, Central Asian, Middle East, African and Latin American countries has accelerated the shift in political and economic power that threatens to upend more than 70 years of US dominance on the world stage.

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Other Data Insights

"Things change gradually at first...

...then all at once..."

China GDP vs UST Holdings (2010-22) (billions)

(click/tap legend to filter data)
China GDP vs UST Holdings (2010-22) (billions)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)
Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Global FX Exchange Reserves (2001-22) (% of total)

(click/tap legend to filter data)
Global FX Exchange Reserves (2001-22) (% of total)

Data Source – World Bank

Western media is starting to pay attention to China’s efforts to influence members of the so-called Global South, or more specifically the BRICS+ and Shanghai Cooperation Organization (with substantially overlapping membership), to denominate international trade in the Chinese Renminbi (RMB), aks the Chinese Yuan (CNY) and/or other local currencies. For very different reasons, Russia has promoted the idea of an entirely new currency for trade settlement. This is an accelerating trend among countries that have formed close economic and political relationships with China.

Coincident with the pivot to the RMB for trade settlement is a growing sentiment among the BRICS+ and SCO members that holding USD as their primary reserve currency poses a risk in the event the US declares sanctions and/or freezes a country’s assets, as happened with Russia and Belarus in 2022.  

The combined effect of these two trends should be observable in a country’s US Treasuries holdings, and that’s exactly what we’re seeing in the chart above – China’s USD and Treasuries holdings peaked at $1.277 trillion in 2013 and declined by more than 32% in 2022.

Things change “slowly at first, then all at once”...

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Due to the recent COVID outbreak in the downtown Puxi District, the Shanghai office is closed to outside visitors. Please feel free to contact us via email or phone to schedule an online meeting.

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FAVORITE SPOTS...🙂

上海茶馆

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Photo - Oriento Gi