It wasn’t that long ago, just 15 years, when few outside China wanted to deal in yuan. It had little weight in the global basket of currencies that are traded daily, so little that it was almost irrelevant. Few countries held yuan as a store of value. And it was mostly used in payments for goods.
But that is starting to change as China embarks on a plan designed to make the yuan – or renminbi – a genuine force in world markets that is designed in the long run to challenge the hegemony of the mighty greenback. Already some foreign currency experts refer to the renminbi as the ‘redback.’
In the latest example of the way China, in a grand plan orchestrated by President Xi Jinping, is pushing its currency into world markets, Argentina paid half of its $2.7bn debt instalment to the International Monetary Fund in yuan rather than in precious US dollars, in August. It did so by tapping a currency swap line, a common arrangement between central banks, that Argentina set up with China 15 years ago. Under a swap line the other party, in this case China, provides the equivalent in yuan of the required amount.
The yuan has a growing role in safeguarding the financial stability of developing economies
A serial defaulter over the years, Argentina is just one year into a new $44bn programme financed by the IMF. The economically beleaguered nation could hardly afford to miss a payment on what is essentially an emergency loan, and China came to the rescue.
It’s the second time that Argentina has dipped into the yuan trough via the swap line to meet its IMF obligations, the last being in June. The swap arrangement is China’s current tactic to deepen the power of its currency. In technical terms it’s an agreement established between two central banks to exchange their currencies to an agreed amount. The pact allows one country’s central bank to obtain foreign currency liquidity from the other central bank, usually to finance bilateral trade and direct investment. In the case of the China-Argentina swap line, it allows Argentine’s central bank to receive yuan from its Chinese equivalent in exchange for an equivalent amount of pesos.
China and Argentina first signed a currency swap agreement in 2009 for 70bn yuan ($10.3bn) and expanded it to 130bn yuan ($19.1bn) in 2018. The arrangement has been a lifesaver for Argentina. In January 2023 the government used it to ward off a foreign exchange crisis. And, furthering the relationship, Argentina will now start paying in yuan for Chinese imports as it runs out of dollar reserves.
Things to come
This latest stepping stone in the internationalisation of the yuan, one of several, has been hailed in China as a precursor of big things to come. Citing experts, the Communist Party-owned China Daily trumpeted in August: “The Chinese renminbi, also known as the yuan, has emerged as a safeguard of global financial stability, shielding an increasing number of developing economies from the spill over effect of drastic adjustments in US monetary policy.”
Weighing in on what is in fact a small deal in terms of the vast forex markets, senior economist Yue Yunxia described the yuan-pesos exchange as “a significant, innovative step in renminbi internationalisation.”
Argentina’s plight was painted as being worsened by the US Federal Reserve’s “aggressive interest rate hikes which intensified the Argentine peso’s depreciation and increased the country’s debt burden.” As such, argued Yunxia, it proved that the yuan has a growing role in safeguarding the financial stability of developing economies as they increasingly opt for the yuan in international settlements and financing. And another economic professor, Wang Jinbin, highlighted the rescue capabilities of the yuan. “It has provided economies suffering from a dollar shortage with an alternative option for trade settlements.”
Up to a point that’s true. Other dollar-short countries such as Brazil and Bolivia also regularly make use of the renminbi in international trade under prearranged swap lines like that of Argentina. And in defiance of international sanctions India recently paid for Russian oil in yuan.
Viewed in context
However, the global data shows that these claims must be taken with a pinch of salt. Even though 2023 has been a good year for the internationalisation of the Chinese currency, its share of global payments is still just 2.77 percent, according to global financial messaging platform SWIFT, while the dollar’s share stands at over 42 percent. As of mid-2023 the yuan trailed well behind the euro, sterling and the yen in global payments.
The yuan trailed well behind the euro, sterling and the yen in global payments
And the greenback shows few or no signs of weakness. As the US Federal Reserve pointed out in a recent paper, the dollar has sailed through recent disruptions such as Covid-19 and US sanctions against Russia that many economists expected would erode its dominance. After carefully reviewing the use of the dollar in its three major global roles – in international reserves, as a currency anchor, and in transactions, the Fed concludes: “We find that the dollar remains the dominant currency and plays an outsized international role as measured by usage in international reserves and other dimensions relative to the US share of global GDP.” In fact, by all these measures the dollar’s international usage is basically unchanged over the past five years and little-changed in 20 years.
Unfortunately for China, its ambitions for the yuan run into the overriding confidence that the world has in the greenback, particularly when measured by its weighting in official forex reserves. In short, as an anchor currency for stormy seas. “The dollar comprised 58 percent of disclosed global official foreign reserves in 2022 and far surpassed all other currencies including the euro (21 percent), Japanese yen (six percent), British pound (five percent), and the Chinese renminbi (three percent),” highlights the Fed.
Put another way, the disruptions of Covid and the war in Ukraine have only served to strengthen confidence in the dollar as an anchor currency.
There’s also a vast amount of paper banknotes held in foreign hands. Indeed the volume has actually increased over the past two decades, both on an absolute basis and as a fraction of banknotes outstanding. By the Fed’s calculations, more than $1trn in banknotes is owned outside the US. That’s about half of all US dollar banknotes on issue, and nobody seems to be in a hurry to cash them in.
Step by step
Typically patient, China has adopted a step-by-step approach to the expansion of the role of the yuan that started in mid-2009. The first move was a new scheme for the settlement of trade claims abroad, primarily through the kind of swap lines used by Argentina. That meant there was a lender of last resort in trade-based renminbi lending.
The establishment of the swap lines has proved crucial. As a 2020 Bank of England paper entitled ‘Jump starting an international currency’ explains, they began to boost usage of the currency. “An upward trend is visible from 2010 onwards with renminbi usage rising from near zero to a peak at around four percent of global payments in 2015. Since then the trend has levelled out and usage is running at just under three percent.”
A big problem for China though is that only those countries that trade heavily with China use the currency the most. Many countries still don’t use it at all. That’s one reason why China is relaxing its strict capital controls. Although it is the largest goods exporter in the world, those controls made it difficult for the currency to be used internationally.
Bit by bit, China is softening its rules. Foreign investors are now allowed to trade in yuan-denominated stocks as well as in bonds via Hong Kong and in exchange-traded funds and interest rate swaps. The last two only became possible in 2022 and 2023.
Simultaneously, notes an analysis by Nikei, “Beijing has signalled it looks to push harder to expand the yuan’s role in cross-border payments.” This is exactly what Argentina is doing in trade transactions.
In late 2023 the yuan looks to be on the rise. In the second quarter of this year it was used in 49 percent of China’s cross-border transactions, topping the dollar for the first time, according to the Nikkei analysis. The main causes are China’s continuing liberalisation of its capital markets and, in what economists call an exogenous trigger, a growing yuan-based trade with Russia that is obviously a direct and disruptive result of the Ukraine war.
This is enough for some to see the yuan becoming the vehicle for eventually undermining the dollar. Citing India’s yuan-based purchase of Russian oil, Radhika Desai, director of the geopolitical economy research group at the University of Manitoba, says it “offers further evidence of the de-dollarisation of the global economy” and a “loss of trust in the crisis-prone US financial system.”
While it will be news to most economists that the US economy is crisis-prone, particularly as it is growing strongly, there are certainly undercurrents in the global financial markets that bear watching.
However, the weight of history is against any upheaval of the dollar. As the Fed points out, the only time in the last 100 years that one currency abruptly lost its dominance was when the dollar replaced sterling in the financial chaos following the First World War, an event formalised in the Bretton Woods Agreement of 1944.