The dollar system is China’s Hotel California

It’s an idea that won’t lie down. US-led sanctions against Russia and the threat that they could ensnare China will prompt Beijing to elevate the international role of the yuan, potentially marking a turning point for the global financial order. Dream on. The structural impediments to the Chinese currency challenging the dollar’s dominance are so great that it’s surprising the notion has received even cursory consideration.
China is starting to use its own currency more for trade transactions, buying coal and oil from Russia and holding talks to price crude purchases from Saudi Arabia in yuan. The country has developed its own cross-border payment system, known as CIPS, as an alternative to the US-dominated Society for Worldwide Interbank Financial Telecommunication, or SWIFT. And the People’s Bank of China is expanding use of its digital yuan. None of these, though, change the fundamental equation that constrains the yuan’s development into a global reserve currency with the power to challenge the dollar.
That’s because the obstacles are primarily political and economic, rather than matters of market
infrastructure. The changes that would enable the yuan to ascend to global heavy-hitter status would also risk wrenching dislocations to China’s economic structure. It’s unthinkable that a government obsessed with stability and control would willingly take on that bet. Chinese leaders may resent the hegemonic power that having the world’s reserve currency gives the US; there’s no sign they’re willing to pay the price of trying to displace it.
George Magnus and Michael Pettis are among China-focused academics who have pushed back at suggestions that we’re on the verge of a step change in the yuan’s role. There’s only one way to have a significant global currency, which is to let foreigners accumulate claims on you, Magnus, research associate at Oxford University’s China Centre, has written. That means giving up control of the current and capital accounts, and being willing to run deficits. China, though, runs persistent current account surpluses — and these (after a brief period of speculation that the country was about to start posting deficits) have widened since the start of the pandemic.
China’s surpluses have gone largely into US dollar assets, giving the country a $3.2 trillion stockpile of foreign-exchange reserves that is the world’s largest. In the past, these purchases helped to hold down the value of the yuan and protect China’s export-oriented economic model. They have also helped to sustain the dollar’s status as the world’s dominant currency. It’s difficult to see how this symbiotic embrace can be unwound without significant disruption on both sides.
Granted, Beijing has loosened control of its capital account through a variety of quota programs over the past decade, giving overseas investors an expanded presence in its stock and bond markets. It remains far from as open as the US, though, and the chances of any near-term relaxation look minimal given the economy’s current weakness. In a report last year, S&P Global Ratings estimated that external ownership of China’s bond market might reach 10% by the end of the decade. Foreign investors hold 35% of the US Treasury market.

—Bloomberg