The Yuan isn’t a Threat to U.S. Dollar Hegemony

David Dollar

The global dominance of the US dollar as the world’s reserve currency is being challenged as the use of the Chinese yuan in international trade and investment is increasing. This trend towards “de-dollarization” has led some countries to reduce their dependence on the U.S. dollar and increase their use of other currencies, including the yuan. 

However, the U.S. dollar still holds a significant advantage with its deep and transparent capital markets that facilitate international trade. While the shift towards a multi-currency, multi-polar world is already happening, it’s unlikely that any currency will replace the dollar as the world’s premier reserve currency anytime soon. 

David Dollar, senior fellow in the John L. Thornton China Center at the Brookings Institution, joins us to discusses the use of the yuan in international trade, the implications Russia’s recent adoption of the yuan, whether it will pave the way for other nations to move away from the dollar, and the impact of the proliferation of other currencies on the power of the dollar and the US-China Great power rivalry.

How have U.S. sanctions affected the use of the U.S. dollar in international trade? What are the potential consequences of this trend? Additionally, how might the increasing use of alternative currencies impact the effectiveness of U.S. sanctions?

U.S. financial sanctions can potentially work quite well because the dollar is clearly the premier reserve currency in the world. I think about 80% of foreign exchange transactions in the world have the dollar on one side of the transaction. So that dominance creates power for the United States. Financial sanctions are typically aimed at banks, in rare cases, central banks, but most commonly commercial banks. If our sanctions cut off a bank from the dollar system, that makes it very hard for them to operate.

I think we’ve overdone it with sanctions. It seems like an easy response from the United States government when it comes to addressing lots of issues in the world. I support the use of sanctions against Russia because it invaded Ukraine. I think that was extreme. I think the use of sanctions to bring Iran to the negotiating table was relatively successful, though, in the end, that deal fell apart. But frankly, the U.S. sanctions minor economies like Venezuela, Cuba, and lots of other entities around the world.

I think, frankly, we’ve generated quite a bit of ill will, particularly from developing countries in the South. Countries are looking for options, they’re gradually trying to shift away from the dollar and that’s incredibly hard. They’re not making much progress, and they’re not likely to make much progress in the next decade. Sanctions are a powerful tool—we tend to overuse them. Naturally, lots of countries, even countries that are friends of ours, are trying to find alternatives, because they’re worried that we’re going to turn this bazooka on them.

I support the sanctions against Russia. Europe has certainly gone along with them, imposing their own sanctions as well, because this is really close to home. However, I find it striking how few countries in the developing world are lining up with us. Countries like Brazil, which is a pretty vibrant, successful democracy. They’ve criticized the Russian invasion, but they won’t join sanctions. Indonesia will not join sanctions, South Africa will not join sanctions.

I think a lot of countries look at the situation and they think, “We don’t like the way the U.S. is using this weapon so easily.” They’re worried that somehow, they might run afoul of us. We can ensure countries that they’ll be safe if they don’t invade their neighbor, but frankly, I think we’ve lost a lot of soft power. People have lost confidence in U.S. decision-making.

Does Russia’s adoption of the yuan have any implications for the global balance of power? Could Russia’s adoption of the yuan pave the way for other countries to attempt to reduce their dependence on the U.S. dollar in international trade?

I think it’s likely to work the other way. I think Russia has made a really serious strategic error invading Ukraine, and this is going to seriously reduce its place in the world for a long time to come. So naturally, they want to shift away from the dollar, because we’ve aimed our sanctions at them, and they can make some deals with China. However, it really ends up being like a barter trade. China needs oil and gas. Russia will sell them oil and gas. The Chinese will negotiate a really good price. This wouldn’t particularly be in Russia’s interest in a real market situation. Russia then has to turn around and buy stuff from China.

However, since so many other countries are sanctioning them, that kind of makes sense for them. It’s an awkward way to do business. If you’re a firm that sells something anywhere in the world, you want to get dollars. You get dollars, and you wait six weeks for payroll. With the dollar, you can move it in and out of our capital markets—they’re deep. They’re reliable. You can get a sixty-day instrument, a thirty-day instrument, or an overnight instrument.

You’ve got futures markets—you can put your money in some kind of instrument in the U.S. Then you can use the futures market to hedge to make sure you don’t get burned by exchange rate movement. When we talk about the Chinese yuan coming along, none of that exists. You can’t move money in and out of China easily. They don’t have deep and transparent capital markets. They don’t have deep futures markets. So, it amounts to a kind of barter trade, which is very inefficient. It’s necessary for the pariah states, like Iran and Russia. However, it’s really hard to see other major economies adopting it in a large way.

China has lots of restrictions on its capital markets. They don’t want to open up. They may say that they would like to see their currency become international, but they don’t want to do the institutional things that would be required for that. Unless they do—and I for one, will be perfectly happy to see China make those institutional reforms—I don’t expect it to happen anytime soon. When you look at the data, the Chinese yuan want accounts for less than 3% of trade settlements worldwide. It accounts for less than 3% of foreign exchange holdings by central banks—it’s extremely minor.

What kind of world are we moving towards? Could it be one where regional currencies are more dominant, or where multiple currencies are used in conjunction with the U.S. dollar, thus diminishing its hegemony? What are the potential benefits and drawbacks of such a system?

We’re moving increasingly to a multipolar world. We already have a multi-currency world. The dollar is dominant, with about a 60% share of foreign exchange reserves globally. The Euro is a very serious reserve currency as well. Europe has opened capital accounts, a good rule of law, and deep capital markets. The Euro is used by quite a few different countries, but there are some factors holding it back. It’s not on parity.

After that, there’s a big drop-off. I think the yen is third, and then there’s the British pound. There’s definitely a trend toward shifting away from the dollar a little bit. However, Banks are not shifting to the Chinese yuan—it’s the Swiss franc or the Australian dollar. These are all relatively small economies. The world can’t put a huge amount of money into, say, the Canadian dollar—it would just drive up your exchange rate and create headaches, and the market isn’t going to do that. But the fact that we see this increase in holdings of currencies like the Swiss franc and the Australian dollar—I think that’s quite interesting.

The yuan share hasn’t quite reached 3%, But it’s there. So, we are moving into a multi-currency world. I personally don’t see any problem with that. I think a little bit of competition is healthy. I already expressed my view that the U.S. has been overusing sanctions. As players around the world shift a little bit more into Euros or Swiss francs, hopefully, that will have a little bit of a disciplining effect on the United States, which should be thinking, “We’ve got this powerful tool, we want to use it for the big things like Russia invading Ukraine, maybe we don’t want to be sanctioning quite so many minor players in the world,” like Venezuela or Cuba.

I think for the yuan to become a large player, even just regionally in Asia, China would have to make some very significant reforms, which I would welcome. They would fall under the general category of strengthening their financial sector and making it more transparent and open. I think that can only be a good thing. A lot of China’s neighbors are very happy to have a high level of trade with China, but frankly, they’re all kind of nervous about China. While they may not be happy with what the U.S. is doing with sanctions, I think they wouldn’t want to put all their eggs in the Chinese basket.

China doesn’t have the same kind of financial power the U.S. does, but it’s used its trade relations to try to punish countries like South Korea or Australia when they make foreign policy choices that China doesn’t like. It’s natural for those partners to try to do business with China but not have a lot of confidence in China’s decision-making. That limits the extent to which they want to be financially integrated with China.

How has China’s rise as a major economic power impacted U.S. economic policies in Asia? What steps could the U.S. take to compete with China more effectively for economic influence in the region? Perhaps you can touch upon the Belt and Road Initiative.

I think the Biden administration is doing a good job of shoring up the U.S. security alliances. Under Trump, I think our security alliances had withered to some extent. Biden has put a lot of effort into rebuilding, which has been successful. However, on the economic side, I give this administration very low marks, because China is not only doing the Belt and Road Initiative, but they’ve also been a leading force in this new trade agreement in the Asia Pacific—the Regional Comprehensive Economic Partnership, which is the biggest trade liberalization deal in history.

The U.S. is just missing the action. We’re not pursuing any new large trade deals. This is really cutting into our soft power. A lot of our partners feel that the U.S. is missing in action in terms of further opening up, or that we’ve taken a lot of measures that go the other direction. We’re promoting buy-American provisions—we put some in the USMCA agreement with Mexico and Canada, in the auto sector. Regarding subsidies that are going to electric vehicles, we’re trying really hard to keep a lot of Asian vehicles and parts out of the U.S. market. It’s generating a lot of ill will, not prosperity.

At its heart, the Belt and Road Initiative involves China lending money to other developing countries to build infrastructure. A lot of the Chinese lending is at commercial rates, and often at flexible interest rates—they do most of their lending in dollars, which tells you something right away about the efficiency of using the dollar versus using the yuan. It’s what the Chinese institutions do, mostly when they lend money to a developing country for infrastructure.

A lot of countries need infrastructure and have taken advantage of this program, But we do now see some debt problems developing. Some big ones have hit the press like Sri Lankan and Zambia, but just more generally now, I think the IMF estimates that 60% of low-income countries are facing debt distress. Now, China’s not the only player here. China’s share of its debt is around 18%. Private bondholders hold about 19% of the debt for those countries—institutions like the World Bank, the IMF, the African Development Bank, etc.

Traditionally, we’ve had a system where there would be a multilateral solution for countries that couldn’t pay their debts. They would be in agreement—all the creditors would take a haircut, the country would commit to various economic reforms, etc. That’s hard to do now, because China’s a big player, and it’s not really very open to these kinds of multilateral agreements. China wants to negotiate country by country. The private bondholders want all their money back. It’s a worrying situation. The scope of the Belt and Road Initiative has declined somewhat because it’s hard for the countries involved to take on new debt.

China’s out there, I think, mostly trying to help other developing countries. But of course, this also supports their exports, they send equipment and steel, and construction workers. They’re out there trying to do this—the Fed raises interest rates, which contributes to the debt distress of developing countries that can’t repay China and can’t start new projects.

How do you see competition between the United States and China playing out in the long run? Is there a winner that comes out on top, or, as we discussed earlier, are we headed toward an increasingly multi-polar world?

I think this is very different from the Cold War for a lot of reasons. The United States did not have much economic integration with the Soviet Union. The Soviet Union didn’t have much economic integration outside of its little world. In the end, there was a clear winner—the Soviet Union collapsed. I think this is a very different situation. We have a lot of integration with China, and more importantly, China is enormously integrated into the world economy, unlike the Soviet Union. I think it’s extremely unlikely that there would be a single clear winner of this competition, as we go out several decades in this century.

I’m pretty optimistic about the United States. I’m an enthusiast for our democratic system. I think we tend to correct mistakes and we have a lot of positives going for us. Demographically, many of the advanced economies have very difficult demographics. China’s labour force is going into decline. The U.S. is one of the few places where the labour force will continue to grow. Canada is another place where the labour force will continue to grow. That’s a big advantage. The U.S. is also resource-rich and technologically advanced.

I remain optimistic, but China will certainly be successful. They have four times as many people. At the moment, they’re likely to become as large an economy as the U.S.—maybe somewhat larger within twenty years or so. However, their demographics are really terrible. Their population is projected to decline sharply throughout the rest of the century. China may overtake the U.S. modestly in the next twenty years, but by the end of the century, the U.S. may very well come back, because of China’s population decline.

Unless they democratize, I think there’s a limit to how far they can go in terms of economic development. Authoritarian countries can do very well, going from the kind of poverty China had in 1978, to their present circumstances, but historically, it’s been difficult for countries to really become technology leaders if they lack a relatively free press and open debate. It’s hard to have great universities when you don’t have freedom of speech. I think all the ingredients that go into creating an innovative society will be difficult for China to achieve. Now, because something hasn’t happened in history, doesn’t mean it can’t happen. Chinese people are determined to succeed. So, I never buy into these collapse stories—that seems unlikely to me.

Will they become a hegemonic power in the world? I’m skeptical about that. For a lot of this century, we may have both the U.S. and China as big superpowers. We need to get along on a lot of issues, like global climate change, and the next pandemic. There are real issues that require global cooperation. Hopefully, we can limit the competition to certain areas.

Given that we have discussed the great-power competition between China and the United States, I’m wondering if you can touch upon where a middle-power country like Canada comes into play.

I happen to think this is an age where middle powers are very important. You face a lot of the same challenges with China that we do because you’re an open democratic economy and society. I think what middle powers do can be very important. For example, it is important that Canada stay in the Transpacific Partnership, especially since the U.S. has pulled out. It doesn’t change the world enormously on day one, but as we look at how things evolve it will have importance.

There are global issues where Canada can stake out its own position—for example, dispute resolution in the WTO. You can provide a bit of a reality check on a big power like the United States. I think you have an enormous stake in preventing big mistakes by the U.S. and China. I think the invasion of Iraq was a big mistake by the United States. Some of the things China’s doing vis-a-vis, Taiwan are big mistakes. Certainly, if they invaded Taiwan, that would be a huge mistake. To the extent that middle powers can play a role in preventing big mistakes from the two superpowers, that’s an incredibly valuable role in the world.

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