- AMERICAN INSTITUTE FOR ECONOMIC RESEARCH - Ethan Yang & Dorothy Chan - JUN 8, 2022 -
The recent dollar-denominated financial sanctions on Russia by the United States inadvertently highlight the growing significance of the yuan (RMB) as an alternative currency. Although today’s immediate concerns revolve around the potential for Moscow to avoid sanctions by transacting in RMB, the significance of the emerging US-China currency rivalry exhibits far broader implications. Many countries are reevaluating their commercial and strategic interests, including increasing their usage of the yuan. As a result, China’s effort to internationalize the yuan is seeing increasing success after six years of stagnation. If the US is to protect its position in the world financial order, it must uphold its sound institutions underpinning the world’s faith in the dollar.
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At the beginning of January 2022, the Chinese yuan’s share of world payments hit a record high.
Countries blacklisted by the US transact in the yuan, which supports China’s currency internationalization plans. For example, nearly half of North Koreans use the yuan for domestic transactions. Iran and Myanmar accept yuan-denominated purchases from China. After its ban from the Western financial system, Russia is now paying off its foreign debt in yuan. In all these cases, dollar-denominated sanctions pushed countries towards the dollar’s competitor, the yuan.
Other countries that maintain trade relations with the US are reconsidering dollars as their trade and investment with China increases. Saudi Arabia, a major oil supplier for the US and China, is considering a yuan-denominated oil deal with Beijing. In 2018, officials from 14 African countries discussed using the yuan as a regional reserve currency. A large impetus likely stems from their involvement in Beijing’s Belt and Road Initiative (BRI), a global economic program that seeks to reorient global commerce around China. In Zimbabwe, the yuan became legal tender after China canceled its debt. ASEAN, a Southeast Asian alliance, adopted bilateral currency swaps with China, which World Financial Review economist Dr. Kalim Siddiqui argues will be the “demise of the US dollar.” Indonesia signed a bilateral agreement to promote the yuan’s use. Baizhu Chen, a clinical finance and business economics professor at the University of Southern California, explains that such countries “feel their economies could be held hostage to US policies” and “want to diversify their risk.”
China also plans to reshape its payment system with the rollout of a digital yuan, or e-CNY. In response, members of Congress raised concerns over the digital yuan’s potential to circumvent US sanctions and threaten the dollar’s status as a reserve currency. In addition, the digital yuan can facilitate cross-border payments without SWIFT, a global interbank messaging system, undermining US interests and bolstering China’s financial power.
Be that as it may, China’s financial structures hinder the internationalization process. Tight capital controls limit convertibility making capital withdrawals out of China extremely difficult for its citizens and investors alike. Foreign businesses registered in China are also bound by strict foreign exchange regulations which delay or restrict business capital transfers. Capital account liberalization is the prerequisite to widespread currency usage, but Peterson Institute for International Economics researchers Nicholas Lardy and Patrick Douglass note that “China does not yet meet any of the conditions necessary for convertibility.”
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