As Donald Trump set about to single-handedly reorganise global trade and supply chain flows, only one headline seems to have given him pause. In times of market stress US Treasuries are the safe haven investment, but as markets plummeted after “Liberation Day”, bond yields initially fell as investors looked for shelter. Then, after days of chaos and confusion, government bonds too started to be sold. Treasuries were no longer the safe bet.
Soon after, Trump paused most of the tariffs except on China. As treasuries sold off, and it became clearer that China was the prime villain in Trump’s trade drama, the question was asked, might China be dumping its vast US holdings? Had Beijing hit the economic nuclear red button?
A few days later reports that China had stopped investing in US private equity only amplified the idea that China was perhaps trying to use its financial clout to pressure Wall Street to get Trump to restrain himself (as if he would listen!).
China may be the factory of the world and boast a trillion US dollar trade surplus, but the world it trades in is a US dollar denominated one, and it doesn’t like it. For the first few decades of Beijing’s reform and opening era, China’s economy grew but its capital account was walled off from the world. The Chinese yuan or renminbi was for domestic use only. Only in 2010, by which time China was already the world’s second largest economy, did it start to open up its currency to overseas use. Since then, the use of the currency has increased but relative to the size of its economy, the Chinese yuan remains a minor global trade currency. Some special transactions denominated in yuan are significant, such as Hong Kong–China trade or Russia–China trade. But very little trade between non-Chinese entities uses the yuan.
Ironically, it is China’s political partners and friends who operate outside of the dollar world.
Since that limited opening in 2010 various pundits have predicted the rise and importance of the renminbi. When in 2016 the International Monetary Fund added the renminbi to its SDR (Special Drawing Rights) basket, some thought the progress would be unstoppable. But there has been no breakthrough when it comes to the use of the Chinese currency. Chinese leaders have often criticised the US dollar-based system, but they have shied away from proposing something different and have been very reticent about making the renminbi a viable alternative.
That China has hugely benefited from the existing global system is not in doubt, but it has also grown ever more wary of the power of the US administration to weaponise the US financial system against companies and countries. US sanctions can be so damaging because they are able to cut off entities from dealing in the world economy. This was amply demonstrated in response to Russia’s invasion of Ukraine, as Russian banks were cut off from the SWIFT messaging system and Russia’s foreign currency reserves held overseas were frozen. What’s the point of reserves if you can’t access them? It is hardly surprising then that Russia-China trade is denominated in renminbi, the Russians simply don’t have anyone else to deal with, they will take the terms the Chinese offer.
Chinese reluctance to directly promote the renminbi as a counter to the dollar is primarily driven by the unwillingness to lose control over its currency. Operating with a largely closed capital account, and a currency rate that is set daily by the People’s Bank of China with narrow daily trading bands, the control-obsessed Chinese Communist Party isn’t going to hand over economic power any more than it is going to hand over political power. Even the proposal that its BRICS partners should try and promote more local currency trade, or perhaps even a BRICS currency, has little support within the group. It is also already on Trump’s radar, with him promising tariffs on the BRICS countries if they trade and move from the dollar.
China then finds itself between a rock and a hard place. It is tied to the US dollar financial system and simply isn’t able to remove itself from it. Its own holdings of US debt stand at around US$1.1 trillion by the best-informed estimates – although claims vary. This amount is too big to sell without driving down prices and negatively affecting its own valuation. It would also only leave China with US cash to invest somewhere else. Even if China does sell its existing dollar assets the nature of a trade surplus means it will only accrue more dollars that it needs to invest.
Not investing in US private (or public) equity might grab headlines but that means the Chinese are cutting themselves off from what remains the most dynamic global companies.
Ironically, it is China’s political partners and friends who operate outside of the dollar world. Russia, Iran and North Korea have all been cut off from the mighty dollar. And while China might like to ally with these renegade states at a political level, it is certainly not foolish enough to want to share their economic fate. China might be an economic whale, but it swims in a dollar sea.
