China eyes challenge to U.S. dollar dominance – but that's easier said than done
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The last few years have exposed some of the fractures in a world currency system dominated by the U.S. dollar. China's leaders see an opportunity — but achieving it will likely prove easier said than done.
The big picture: For all the gripes that nations around the world have about the United States' stewardship of the dollar, displacing the dollar would require China or any other potential rival to build infrastructure and make sacrifices that would be no easy feat.
- For China, it would mean relaxing its strict controls on the flow of capital into and out of the country, an important tool of state power — and a contrast to the U.S., where dollars flow more freely.
Driving the news: Published remarks by Chinese President Xi Jinping in Qiushi magazine, a leading ideological journal for the Chinese Communist Party, extol the importance of the nation achieving global financial might.
- "What constitutes a strong financial nation?" the article says per Bloomberg's translation. "First, it should have a powerful currency, widely used in international trade, investment and foreign exchange markets, holding the status of a global reserve currency."
Zoom out: The dollar is used worldwide in trade — even when neither party to the transaction is American — and by global investors seeking a safe place to park money.
- That gives the U.S. government leverage in global affairs that it has not been shy about using, deploying sanctions as a tool of power.
- The U.S. can essentially block enemies — whether in Russia, Iran, North Korea, or beyond — from the mainstream global financial system, to the consternation even of nations with broadly friendly ties to Washington, like India and Brazil.
Yes, but: If China wants to replicate that power and take U.S. primacy down a peg or two, a magazine essay alone won't cut it.
- Dollar dominance is powered by a complex network of interconnected factors.
- There's the availability of trillions in U.S. Treasury debt that can be freely bought and sold around the world, an independent central bank, a currency that floats based on market conditions, and complex payment systems built over decades.
What they're saying: "There is now this desperate desire to diversify away from the dollar, but not very much in the way of high-quality assets to diversify into," Eswar Prasad, author of a new book called "The Doom Loop," about the unraveling international economic order, tells Axios.
- "So for all the talk of dollar decline, for all the talk of the dollar being knocked off its pedestal, the reality is that we've seen significant net inflows into U.S. financial markets over the last 12 to 14 months," says Prasad, an economist at Cornell University.
State of play: As for Xi's latest calls to establish greater Chinese financial pre-eminence, Prasad says that China's work on cross-border banking is already making the renminbi more useful for transactions between non-U.S. entities.
- "Transactions between pairs of emerging market currencies are becoming easier," Prasad says. "China and India will no longer need to exchange their respective currencies for dollars to conduct trade."
- China has also made it easier for foreign investors to acquire Chinese bonds, he said, but capital controls and a lack of trust in China's institutions act as limits on renminbi-denominated securities as an alternative to Treasuries.
The bottom line: "The renminbi's share in emerging market economies' reserve holdings will undoubtedly increase on account of diversification motives and geopolitical tensions," Prasad says.
- But "this increase will be constrained by China's capital controls and weak institutional framework."
