US itself is accelerating the de-dollarization process
De-Dollarization and the Fall of American Hegemony
Ever since the Fed ended its ultra-loose monetary policy and turned to a radical rate hike approach, the international financial market has been in turmoil with many currencies depreciating sharply. That has forced many countries to diversify their foreign exchange reserve assets. – AP
MARKET expectations for the Federal Reserve to end interest rate hikes have picked up as core inflation data in the United States has dropped and the University of Michigan’s consumer confidence index fell from 67 in February to 62 in March – yet worries abound about the outlook for the US economy.
Former US Treasury secretary Larry Summers said recently that it is too early to say that the US has shaken off the financial woes caused by its rapid interest rate hikes. The US economy is likely to experience a serious recession as a result of the recent banking crisis, with little chances of a “soft landing”. With recession expectations picking up, the factors supporting a strong US dollar are disappearing.
Ever since the Fed ended its ultra-loose monetary policy and turned to a radical rate hike approach, the international financial market has been in turmoil, with many currencies depreciating sharply. That has forced many countries to reduce holdings of US Treasuries, diversifying foreign exchange reserve assets.
In mid-march, Russia’s central bank reported that the ruble and “friendly” currencies together accounted for 52% of Russian export settlements at the end of 2022, surpassing the share of the US dollar and euro for the first time on record.
The members of Asean agreed at the end of March to strengthen the use of local currencies in the region and reduce reliance on major international currencies in cross-border trade and investment. On April 1, India and Malaysia agreed to settle trade in Indian rupees.
Data show that the proportion of US dollar reserves and assets in global central banks’ foreign exchange reserves has dropped from 65.46% in the first quarter of 2016 to 59.79% in the third quarter of 2022.
Despite its declining status, the US dollar still accounts for the largest share of global trade settlement, central banks’ foreign exchange reserves, global debt pricing, and global capital flows. However, the abuse of the US dollar hegemony has led many countries to launch a “de-dollarisation” campaign. The more the US dollar is used as a weapon, the faster it will be abandoned by other countries.
It’s unrealistic that some in the United States want to safeguard the benefits brought by the US dollar as a leading international currency, but don’t want to shoulder corresponding international responsibilities. – China Daily/Asia News Network
The currency’s correlation with an MSCI Inc index of its developing-nation peers rose to record in September on a weekly basis before edging back slightly amid the Omicron outbreak, Bloomberg data show.
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BEIJING: The Chinese yuan is having a greater impact on its emerging-market counterparts than ever before and may play a crucial role in determining their performance in the coming year.
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The currency’s correlation with an MSCI Inc index of its developing-nation peers rose to record in September on a weekly basis before edging back slightly amid the Omicron outbreak, Bloomberg data show.
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While the close relationship is partly a result of China’s large weighting, it’s also been driven by the yuan’s links to the Brazilian real reaching the strongest since at least 2008, and that with India’s rupee touching a three-year high.The yuan’s rising global influence is yet another sign of China’s deepening connections across the world economy.
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Investors are increasingly being drawn to its bonds as an alternative to United States Treasuries, while some banks are calling for the yuan to join the dollar, euro and yen as a global reserve currency.
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Yet with China’s potential being offset by murky policy making and regulatory crackdowns, being tied too closely to the yuan may also backfire.
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“China is going to be a very important element of emerging-market stability and the growth picture,” said Magdalena Polan, principal economist at PGIM Ltd in London.
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“The willingness for Chinese policy makers to stabilise growth will be very important to the outlook for Latam and Asia and South Africa, as countries there still rely quite a lot on exports from China.”
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While correlations can be measured in many ways, China’s increasing presence in global trade has progressively boosted the yuan’s links with those of its emerging-market peers.
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In 2000, the average developing nation sent only 2.2% of its exports to China, while that proportion has now grown to 11.3%, according to data from Societe Generale SA.
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The investment bank says the yuan’s relative stability has traditionally made it most closely correlated with those of its emerging-market peers with strong and credible policy makers such as Mexico, Chile and South Korea.
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Since the US-China trade war in 2018, however, the yuan’s links with emerging markets as a whole have grown stronger, with the average correlation rising to 83% that year, according to SocGen data.
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There’s a risk of course that those very connections may also weigh on emerging-market currencies if the yuan begins to weaken. The major risk of that happening looks to be due to potential policy divergence, with the People’s Bank of China expected to ease monetary policy in 2022, just as central banks from the US, UK and Australia start to tighten.
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The yuan will face a particular challenge as the Federal Reserve beings to raise borrowing costs, a move that is anticipated to lead to a stronger dollar and outflows from emergin
`g markets. Still, China’s currency has so far shown itself to be relatively resilient to monetary policy at home and abroad.
China’s economy has become an increasingly important influence on global growth over the past decade, and a vital one for emerging markets, according to JP Morgan Private Bank.
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“Since the financial crisis, we’ve had mini cycles in global emerging markets, largely coincident in China’s property and credit cycle and since the crisis that has been the key driver of the outlook in emerging markets for the most part,” said Alexander Wolf, head of investment strategy, Asia, at JP Morgan Private Bank in Hong Kong.
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The yuan’s relative resilience this year has also played a role in limiting fluctuations across emerging markets, in what has otherwise been a very tumultuous 12 months.
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“The fact that the yuan’s not doing too much I categorise it as a volatility suppressant,” said Paul Mackel, head of global foreign-exchange research at HSBC Holdings Plc in Hong Kong. “We believe that stability can last for longer.” — Bloomberg
The dollar is central to the global monetary system – used worldwide as a unit of account, store of value and medium of exchange. Most commodity and forex contracts are denominated in it. It represents more than one-half of all cross-border interbank claims (a proxy for international payments). That’s five times US share of world goods imports, and three times its share of exports. About two-thirds of world reserves is held in US dollars.
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The yuan’s stability is partly by design, and by good luck; backed by foreign exchange reserves held steady at US$3.1 trillion since mid-2016.
TODAY, the world’s financial rhythm remains American. The US dollar assumed the role of the world’s dominant reserve, payment and settlement currency after WWII. The country’s position as the sole financial superpower gives it extraordinary influence over the destinies of nations.
For 70 years, the United States has used this power rather routinely, as a matter of reality. Of late, however, it has been engaged in “financial warfare” in the service of its foreign policy. This has prompted nations to “break free” of US dollar hegemony, including preventing “US sanctioned nations” free access to US dollar-based financial system with devastating impact.
The dollar is central to the global monetary system – used worldwide as a unit of account, store of value and medium of exchange. Most commodity and forex contracts are denominated in it. It represents more than one-half of all cross-border interbank claims (a proxy for international payments). That’s five times US share of world goods imports, and three times its share of exports. About two-thirds of world reserves is held in US dollars.
It is the preferred currency of central banks and capital markets (accounting for 65% of global securities issuance). The irony is people rushed to buy dollars during the subprime crash, even though Wall Street caused it. They did so again in March this year despite US bungled response to Covid19. The global finance plumbing is US dolarbased – most international transactions are ultimately cleared in US dollars through SWIFT (banks’ main cross-border messaging system) and CHIPS (Us-centric clearing house network) through New York by US “correspondent banks.”Denied access to this infrastructure, the institution is isolated and financially crippled. The United States began flexing its financial muscles (including imposing hefty penalties) after the terrorist attacks of September 2001.
Trump has since “weaponised” it to a new level – to-date, it has over 30 active financial and trade-sanctions programs. Early this year, it used this dominance to cut-off support to the Iran and Iraq regimes, adversely affecting their use of oil revenues.
This use of the dollar to extend its policy reach is “an abuse of power,” i.e. bullying; Russia refers to its use, a “political weapon.” Even allies (EU, Japan, UK) are concerned Trump is undermining US role in maintaining orderliness in global commerce and finance. There is already widespread talk to “dethrone” the US dollar, through the dedollarisation of assets; more use of domestic currencies in its trade workarounds and swaps; and new banking payments mechanisms and digital currencies.
Also, nations have expanded settlement of bilateral trade in their own currencies, or gold; even barter. Russia has gone the furthest, including dedollarising parts of its financial system; reducing US dollar share of its foreign reserves (40% to 24%); cutting its bank’s holdings of US dollar Treasuries to under Us$10bil from Us$100bil; bringing down its exports denominated in US dollar to 62%; and shifting US dollar trade with China and India to non-us dollar settlements; and denominating over 40% of its crude oil tenders in euros.
Like Russia, China has begun to set-up “building blocks” to become more autonomous, including a yuan-denominated crude oil futures contract (“petroyuan”) on the Shanghai exchange. US allies are flirting with it, too. But, EU first has to reform the inner workings of the euro and complete work on banking union, fiscal integration, etc., before it is ready to create a global electronic invoicing euro currency.
Reserves option
US dollar’s role as a reserve currency point to three distinct benefits: (i) lower transactions cost; (ii) macroeconomic policy flexibility, including foreign financing of its deficits; and (iii) leverage to benefit allies. Of course, it carries costs: (a) tends to hurt exports by being strong and stable; (b) overhang of debt overseas opens domestic economy as hostage to sudden capital movements; and (c) needs to bail-out the system.
That’s why the UK, Japan and Germany shied away. However, because the world has changed, EU has since started to push for a stronger international role for the euro. But becoming a serious reserve currency requires: (a) large, deep and liquid capital markets; (b) a secure bonds infrastructure, especially in government bonds; (c) wide use in world trade; and (d) a big economy that’s integrated into global markets.
Without fiscal union, EU lacks a supranational, liquid euro bond; its capital markets are not robust enough – a real banking union would help. Euro’s share of global reserves is down to 20%. Russia also tried – cuts US dollar share of its reserves to 24%. Issues most debt in roubles and euro; only 60% of its exports is settled in US dollars, and 40% of its oil sales contracts is denominated in euros. It has still a long way to go.
China had longed wish to internationalise. But, its capital controls remain a serious problem: it limits how much outsiders can access its currency. In 2017, Bond Connect was launched – allowing foreigners to invest in offshore bonds through Hong Kong, and scrapped investment quotas.
China has since made good progress: (i) offshore yuan deposits are rapidly rising; (ii) issues of yuan “dim-sum” bonds are getting popular; (iii) boom in forex transactions suggests growing usage, especially in hubs like Hong Kong, London, New York and Paris; (iv) more offshore investment products are denominated in yuan; and (v) Hong Kong today lists ETFS, gold futures and property investment trusts in addition to Chinese equity. China’s advances are global: it has a vast global trade and investment network; Chinese FDI is mainly in yuan; it settles 15% of its foreign trade in yuan. Today, more globally yuan payments are processed by banks.
One-fifth of European trade with China is settled in yuan, as is 55% of payments among them. Since 2018, yuan-denominated oil futures were launched in Shanghai, as are margin deposits on iron ore futures in Dalian. China’s commodity exchange is emerging. Most of all, central banks are warming up to the yuan – since inclusion in IMF’S SDR (a basket of five elite currencies), its share of global reserves has risen to 2.1%;
China has already signed currency swap arrangements with over 60 nations. Today, the “yuan bloc” accounts for 30% of global GDP – second only to US dollar (at 40%). China opened up its US$13 trillion bond market (world’s second largest), which accounts for 51% of all bonds issued by EMES.
Foreigners now hold 3% of this market and 9% of its government bonds. Its main attraction: good yields and diversification benefits. Further, the yuan has been among the most stable currencies in the world since mid-2016. Its real effective exchange rate – against the basket of currencies of its trading partners, adjusted for inflation – has risen by just 0.2% over the past four years. The yuan’s stability is partly by design, and by good luck; backed by foreign exchange reserves held steady at US$3.1 trillion since mid-2016.
New initiatives
US geopolitical rivals’ desire to escape the dollar dominance is real. In designing its new e-yuan, China wants a head start on the dollar; it is reported to be considering creating a common cryptocurrency with other BRICS nations (Brazil, Russia, India and South Africa). Similarly, on its part, EU is determined to encourage its members to eliminate “undue reference” to US dollars in payments and trade invoicing.
EU’S main initiative has involved Iran. It tried to create a way for its banks and firms to trade with it through Instex (a clearing house created for this purpose by Britain, France and Germany, with European Commission’s support) by-passing US dollars or SWIFT.
The stuttering performance of Instex reflects the sheer scope of the dollar reach: US claims jurisdiction if a transaction has any American “nexus,” even though not denominated in dollars. Despite this, more EU states are determined to join Instex. It’s EU’S intention to expand its financial reach – through a network of global electronic central bank digital monies that serves as a global invoicing currency, excluding US dollars. Also, its capital market needs greater depth and liquidity, key factors in choosing a currency for commerce. As Trump continues to use sanctions aggressively, efforts to circumvent them will accelerate. The reality is that US does not have a monopoly on financial ingenuity.
What then are we to do
There’s no question the world urgently needs a multinational currency reserve regime. The dollar is being weaponised to bully. This won’t do. Nations, including US allies, are looking for and working on an effective but viable and sustainable option. This will take time. The search is still very much work-in-progress. Euro and e-yuan look promising. But they have a way to go. Like it or not, any e-currency has to be central bank-backed to be credible, and where the public can readily access it.
Still, central banks face hurdles in offering dedicated digital currencies and related accounts to the public. Understandably, many central banks have been hesitant in creating digital currencies. As I see it, they remain worried on how to monitor transactions to prevent fraud and hacking, and whether digital currencies should be linked to interest rates. It’s a responsibility, I think, central banks really don’t want to take-up.
By Lin See Yan, Kuala Lumpur, June 22, 2020
Former banker, Harvard educated economist and British chartered scientist, Prof Lin of Sunway University is the author of “Trying Troubled Times Amid Trauma &Tumult, 2017–2019” (Pearson, 2019). Feedback is most welcome.
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