Politics
Dedollarization: China has very few alternatives to the US dollar
- Western sanctions have forced Russia to rely on the Chinese yuan for its reserves and trade.
- China is also concerned about sanctions. But unlike Russia, it has no alternative to the dollar.
- China's financial system is deeply tied to the greenback, limiting diversification options.
Massive Western sanctions against Russia have so isolated its economy that it now relies on the Chinese yuan for reserves.
Russia's isolation also worries China, whose 18 trillion dollars Russia's economy far exceeds Russia's $2 trillion by relying on a financial system based on the U.S. dollar, prompting calls for the country to reduce its financial system's exposure to the greenback .
However, unlike Russia, Beijing has far fewer alternatives, writes Robert Greene, a nonresident scholar at the University of Washington. Carnegie Endowment Asia Program and Cyber Policy Initiative.
“Russian authorities have diversified the country's foreign exchange reserves largely by purchasing renminbi assets, but a similar option is not possible for Chinese authorities,” Greene wrote Thursday.
There are many reasons for the limits of China's dedollarization.
These include the greenback's well-established role in global commodity trade and foreign exchange reserves far larger than those of Russia, wrote Greene, a former senior adviser to the U.S. Treasury. He is also vice president of the consulting firm Patomak Global Partners.
China continues to return to the dollar
Certainly, China is working to reduce its dependence on the dollar. In particular, it set up the cross-border interbank payment system (CIPS), based on the yuan, to process transactions. However, many CIPS participants are closely tied to the dollar financial system and potentially subject to U.S. sanctions.
Meanwhile, about half of China's foreign exchange reserves are held in dollars. The country's dollar assets in 2023 were more than 15 times the value of Russia's in 2019, Greene wrote. The Russian central bank significantly reduced its dollar-denominated foreign exchange reserves starting in 2020, before its invasion of Ukraine, meaning China's dollar reserves could be much higher than Russia's at this point .
“China could also, in theory, modestly diversify some dollar reserves into public debt securities denominated in the currencies of relatively small and open economies,” Greene wrote.
However, assets in non-major currencies outside of the dollar, euro and yen “may not present significantly less geopolitical risk than the dollar.”
In addition to foreign exchange reserves, China's largest state-owned financial institutes, including its four major state-owned commercial banks, are deeply interconnected with the U.S. financial system.
“These institutions often rely on dollar funding to finance their overseas operations and, in recent years, have sometimes maintained dollar-denominated debts worth significantly more than dollar-denominated assets,” he said. writes Greene, citing a research paper published by the Federal Reserve Bank of Boston in 2022.
China's ties to the dollar manifest themselves in other ways.
Most of China's Belt and Road Initiative loans have been denominated in dollars. Many Chinese companies have resorted to US dollar equity financing.
China also actively manages its exchange rate against the dollar, Greene added.
The dollar is still king
In short, China simply cannot copy the Russian model of sanctions protection and will likely continue to revolve around the dollar financial system in the near term.
It is not just China that is seeking to break away from the king of the dollar.
Discussions about dedollarization come back in waves every few years since at least the 1970s.
But the dollar still reigns, thanks to its position as a safe haven.
Like James Lord, Morgan Stanley head of foreign exchange strategy for emerging markets, interviewed in May podcast; “What currency would you want to own when global stock markets begin to fall and the global economy tends to head into recession? You want to position yourself in U.S. dollars because that is historically the reaction of the exchange rate to these kinds of events.”
“At the end of the day, the king dollar doesn't really have a challenger,” added Michael Zezas, head of US public policy research at the firm.
