Moving toward a multipolar currency system

Growing internationalization of the Chinese currency part of a 'de-dollarization' trend that seems to be gathering pace

Even a decade after the global financial crisis, the world economy has not fully recovered because the structural problems that precipitated the crisis have not been eliminated. Complicating the matter is a series of policies the United States has adopted to shift trade and financial risks.

The US dollar has dominated the global financial system for historical reasons. The exchange rate system that pegged other currencies to the dollar served as the cornerstone of the Bretton Woods system. However, the Bretton Woods system itself collapsed after the US terminated convertibility of the dollar to gold in 1971, ushering in an era of free-floating currencies and making the dollar a reserve currency.

But the Trump administration's protectionist and unilateral policies, together with massive US debts, have exposed economies to the risks of the free-floating dollar, prompting many countries to break away from the US dollar regime and shift toward a multipolar currency system.

The US has imposed steep tariffs on imports from a number of economies, including China, Russia, Brazil and India, as well as from traditional allies such as the European Union, Japan and the Republic of Korea. The result of this move on the global industrial chain could necessitate the reconstruction of the world trade order. There is also widespread concern that the United States might use the reserve currency status of the dollar to impose new sanctions on some countries.

The prospects of US financial resurgence, on the other hand, have dimmed because of the tax cuts the Trump administration has implemented. According to the US Congress Joint Committee on Taxation, the tax cuts will increase the country's fiscal deficit by $1.45 trillion in the next 10 years. And although fiscal easing to boost the economy, combined with tightening monetary policy, will accelerate the growth rate of US treasury bond yields, the policy will be unsustainable in the long run.

Also, along with the shrinking trade surplus in emerging markets, thanks to the Trump administration's tariff wars, demand for US bonds might be suppressed. The growth of the US bond yield rate would further raise financing costs and create more systemic risks. In fact, countries such as the Netherlands, Germany and Switzerland have recently taken back or announced they will take back gold reserved in the US.

Thus, developed countries, emerging market economies and oil-producing states are all unhappy with the fluctuating dollar.

The "de-dollarization" trend seems to be gathering speed. First, the use of other currencies in the oil trade is becoming increasingly popular. In November 2016, Russia introduced Urals crude oil futures denominated in roubles at the Saint-Petersburg International Mercantile Exchange. The Iranian Oil Bourse has been using the euro, the Iranian rial and a basket of other currencies to settle oil deals since July 2011. And Chinese crude oil futures denominated in yuan became tradable at the Shanghai International Energy Exchange in March this year.

Second, the creditor countries of the US have sharply reduced their dollar assets. Apart from the biggest US creditors - China and Japan - a dozen other countries including Russia and Turkey have reduced their dollar assets. This has caused the US government bond to drop to its lowest level since October 2011. Surprisingly, even the United Kingdom, Ireland, Switzerland, Luxembourg, Canada and Mexico have either sold or have decided to sell the US bonds in their possession.

Moreover, the share of the dollar in global currency reserves has declined. International Monetary Fund data released in July showed the ratio of the dollar reserves fell for the fifth consecutive quarter in the first quarter of this year - from 62.72 percent of the allocated reserves in the fourth quarter of 2017 to 62.48 percent - while non-dollar reserves increased. For instance, reserves held in yuan grew in the third quarter to 1.4 percent of the allocated reserves from the original 1.2 percent, while the shares of the pound sterling and euro jumped to 4.68 percent and 20.39 percent, respectively.

From a settlement currency, to money of account, to a reserve currency, the internationalization of yuan, has entered a new phase. By January this year, more than 1,900 financial institutions had listed the yuan as a payment currency. European countries, including Germany, France, Spain and Belgium, have in succession announced they would add the yuan to their foreign exchange reserve pool and accordingly reduce their dollar reserves.

Furthermore, along with the internationalization of the Chinese currency, global investors have increased their holdings of bonds denominated in yuan. According to China Central Depository and Clearing Co, as of the end of August overseas investors held 1.41 trillion yuan ($205.54 billion) worth of such bonds - Chinese national debt of 1.03 trillion yuan - thanks to an increase of 53.95 billion yuan in a single month in its 18th month of growth.

The share of foreign investors in China's government debt market has jumped from 0.88 percent last year to 5.85 percent now - which shows that the status of the yuan in the global market has increased and yuan-denominated bonds have become a safe bet for investors.

A multipolar currency system is emerging, and the trend of countries reducing their US debt holdings and signing bilateral currency swap agreements is gaining pace, but expecting a massive selloff of US dollars would be unrealistic.

Zhang Monan is a senior fellow and professor at the China Center for International Economic Exchanges.

(China Daily European Weekly 09/28/2018 page13)