Summary by Geopolist | Istanbul Center for Geopolitics:
The paper delves into how China’s reliance on the U.S. dollar presents a vulnerability in light of escalating tensions and the precedent set by sanctions on Russia. Despite China’s growing use of the renminbi in cross-border trade and efforts to diversify away from the dollar, its financial system is still closely tied to dollar-denominated assets. Beijing has implemented policies to reduce dollar dependency, but significant challenges, including global commodity markets’ reliance on the dollar, the complexity of currency diversification, and geopolitical constraints, limit its ability to achieve de-dollarization.
Key points:
- U.S. Sanctions and Dollar Exposure: The U.S. sanctions on Russia, particularly targeting Russia’s central bank and major financial institutions, have created a sense of urgency within China to rethink its exposure to the dollar. Chinese scholars and policymakers fear that similar actions could be taken against China, leading to frozen reserves or restricted access to global dollar-denominated markets. This possibility has spurred calls for China to reduce its dollar exposure.
- Comparison to Russia’s Dedollarization: The report compares China’s potential de-dollarization efforts to Russia’s “Fortress Russia” strategy, which reduced Russia’s dependence on the dollar after the annexation of Crimea in 2014. Russia successfully diversified a significant portion of its reserves into euros, yuan, and other currencies. However, China’s challenge is far greater due to its larger financial system, its deeper entanglement with the global dollar network, and the sheer volume of its dollar reserves.
- Currency Diversification Obstacles: While China has increased its gold reserves and experimented with using non-dollar currencies like the euro and yen, significant obstacles remain. These currencies’ market depth and liquidity are far lower than the U.S. dollar’s. For example, the eurozone and Japan do not have the same supply of high-grade government debt securities that China could easily acquire. Large-scale purchases of non-dollar assets by China could also trigger adverse reactions in these markets, potentially affecting their trade competitiveness and financial stability.
- Interconnection with Global Financial Markets: A large portion of China’s external debt is denominated in dollars, and many Chinese institutions rely on dollar funding for their global operations. In particular, China’s largest state-owned banks have substantial dollar liabilities, underscoring their vulnerability to any U.S. sanctions or restrictions on dollar transactions. The banking sector’s reliance on the dollar is a significant impediment to Beijing’s de-dollarization ambitions.
- Renminbi’s Limitations: Although China has made progress in promoting the renminbi’s use in cross-border trade, the renminbi remains a minor player in global markets. Much of the increase in renminbi transactions reflects financial flows between mainland China and Hong Kong, rather than global trade. The renminbi’s use in global commodity markets is still limited, with the dollar dominating these sectors. The report notes that even if China continues to increase the renminbi’s role, full de-dollarization is unlikely in the near future given the depth of global dollar markets and the strategic importance of dollar liquidity.
- Geopolitical and Economic Implications for U.S. Statecraft: The paper highlights how U.S. economic statecraft, particularly its use of sanctions, could shape China’s de-dollarization trajectory. Any U.S. sanctions targeting Chinese financial institutions would accelerate China’s efforts to build non-dollar financial channels, possibly leading to a parallel financial system less susceptible to U.S. influence. However, such actions could also destabilize global financial markets due to the deep interconnectivity between U.S. and Chinese financial systems.
In conclusion, while China’s de-dollarization efforts are advancing, they face significant structural and geopolitical hurdles. The global dominance of the dollar, China’s integration with dollar-based financial systems, and limitations in alternative currencies make full de-dollarization a challenging, long-term goal.
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