With the increasing angst between China and the U.S. and Chinese siding up to Russia since the Russian invasion of Ukraine we have seen more talk of moving away from the US dollar. The ‘outsider’ nations have been moving to protect themselves since the US weaponized the US dollar to impose financial sanctions on Russia after its invasion of Ukraine so as to decrease their own vulnerability to similar sanctions. China and the BRIC nations are at the forefront here. China has dramatically increased use of the yuan to buy Russian commodities over the past year, with nearly all of its purchases of oil, coal and some metals from Russia now settled in the Chinese currency instead of U.S. dollars.
China has struck trade agreements to use its currency directly in trade deals. Each financial crisis we hear of gold, and now crypto replacing the dollar. The cold reality is that there is no conventional alternative to the dollar as the world’s reserve currency. Scandals like FTX, collapses of Silicon Investment and Signature Bank, and multiple Crypto exchange frauds undermine Crypto markets. China may have ambitions to chip away at that dominance as it buys up gold and does these trade deals. It would take a revolution for the Communist Party to give up the tight control of its financial system.
Factor in that Asia is the epicenter of technology manufacturing – with the global “tech” Bubble in grave jeopardy. The confluence of China’s bursting Bubble, Japan’s foolhardy monetary policy gambit, and highly levered systems puts Asia today on a Collision Course with rapidly deteriorating macro and micro fundamentals. I’ll assume mounting hedge fund and derivative issues.
Geopolitically the landscape is constantly evolving since the Russian invasion of Ukraine, China’s Xi’s power grab and Covid lockdown protests, a move to the right in Italy and Russia’s annexation in eastern Ukraine of territories, after taking Crimea in 2014 and a divisive election in Brazil and the US deepening partisan divide.
China Deals in Yuan with Russia
Since the invasion of Ukraine and their seizure of about half of Russia’s $US640 billions of dollar-denominated foreign exchange reserves, China and Russia have been conducting most, about two-thirds of their significantly increased trade in their own currencies. The yuan is now the most traded currency in Russia and Russia also now holds about a third of the world’s yuan-denominated foreign exchange reserves.
“China has dramatically increased use of the yuan to buy Russian commodities over the past year, with nearly all of its purchases of oil, coal and some metals from its neighbor now settled in the Chinese currency instead of dollars… The switch to yuan to pay for much of a roughly $88 billion commodities trade in the wake of the Ukraine war accelerates China’s efforts to internationalize its currency, at the expense of the dollar, although strict capital controls are expected to limit its global role in the near term. In March, the yuan – also known as the renminbi – became the most widely used currency for cross-border transactions in China, overtaking the dollar for the first time…”
May 11 – Reuters (Chen Aizhu)
China Deals in Yuan with Saudi Arabia
China did a deal with Saudi Arabia to pay for oil purchases in yuan, the first time in nearly half a century that the Saudis have been prepared to accept anything but the dollar in exchange for their oil. China is seeking similar deals with other Middle Eastern oil producers. China’s China National Offshore Oil Company and France’s TotalEnergies struck the first deal for a LNG cargo denominated in yuan.
China Deals in Yuan with Brazil
China and Brazil announced they would use their own currencies to settle trade and that Brazil would connect to China’s fledgling international payment system. The system is its alternative to the US-dominated SWIFT international payments and messaging system.
China Deals in Yuan with India
India is also trying to do more direct deals that reduce its exposure to the dollar. In Latin America and South-East Asia, countries are also trying to circumvent the use of the dollar by doing more deals in their own currencies. China and Russia are talking about the creation of a “BRICs” (Brazil, Russia, China and India) reserve currency, perhaps backed by a basket of commodities.
“Signs of de-dollarization are unfolding in the global economy, strategists at the biggest U.S. bank JPMorgan said…, although the currency should maintain its long-held dominance for the foreseeable future. The strains of steep U.S. interest rate rises and sanctions that have frozen Russia out of the global banking system have seen a fresh push by the ‘BRICS’ nations, Brazil, Russia, India, China and South Africa, to challenge the dollar’s hegemony. JPMorgan strategists Meera Chandan and Octavia Popescu said that while overall dollar usage is within its historical range and the greenback remains at the top of the pack, a closer look shows a more bifurcated picture.”
June 5 – Reuters (Marc Jones)
US Dollar Being Usurped?
China’s Two Yuans
- USD/CNY is the onshore yuan and is permitted to trade plus or minus 2% from the daily reference rate.
- CNH is the offshore yuan. USD/CNH has no restrictions on its trading range.
- A significantly stronger or weaker rate than expected is typically considered a signal from the PBOC.
- The IMF lifted the yuan’s weighting in its Special Drawing Rights currency basket in May
The flipside of China’s move away from the dollar for Russia and friends is its weakened position against the US dollar.
Over the past month or so, the Greenback has rebounded after being down about 8.5% from a peak last September, as measured by the US Dollar index or the WSJ Dollar Index. The Chinese Yuan has been particular weak with the PBoC meanwhile is trying to slow recent CNH weakness vowing to curb speculation following a drop to 7.0750, its weakest since December. From there we have seen the Yuan slide further to 7.2100.
China in a move to at least slow the slid of the Yuan set its daily reference rate for the yuan on June 25 at a stronger-than-expected level to slow its slide, as the managed currency weakened in the offshore market while there was a holiday on the mainland.
Bloomberg reported The People’s Bank of China set the fixing at 7.2056 per dollar, 77 pips stronger than the average estimate in a Bloomberg survey with traders and analysts. The offshore yuan slid to the weakest since November on Friday, as the nation’s economic recovery slowed and its stimulus measures disappointed investors. The onshore markets will reopen after a two-day holiday.
“It may mean a sign to partly stabilise the yuan, by preventing excessive moves after moving above 7.20,” said Becky Liu, head of China macro strategy at Standard Chartered. “But it doesn’t imply a harder line by the PBOC to defend any level, or aiming to alter the trend.”
The dollar has been oscillating lower on pricing of the end of the Fed’s tightening cycle, that has reversed over the past few weeks. The move comes after a combination of short covering, higher interest rates and safe haven buying. These popular macro trades tend to be risk on or risk off and feed each other, the forex moves accordingly flow into other big shorts such as bonds, U.S. tech stocks, and commodities, and European equities.
2023 had been the worst start for the dollar to the year since 2018 with the interest rate forwards feeding the pullback as they price in the terminal rate for the Federal Reserve to end its most aggressive program of interest-rate increases since the 1980s.
While with the increase of Chine trade in particular the dollar in global trade and financial transactions has waned, it is not likely that the end of dollar dominance will occur soon. Simply, the US runs large trade deficits and therefore creates more dollars than its domestic economy requires, it has very deep and liquid markets to absorb the savings of those countries with big trade surpluses, the dollar floats freely with very limited capital controls and it has a legal system that the rest of the world generally trusts. Yes, all these factors are under siege much of it by Russian and Chinese propaganda and their lapdogs like Iran.
China has none of these things and is most unlikely to change its communist economic model to run large trade deficits to absorb the rest of the world’s savings, or completely liberalize its financial markets. Just this week we saw the HKMA (essentially part of China) battle to protect its USDHKD band. We don’t see them abandoning its managed exchange rate policy or its capital controls let alone create a transparent and trusted judicial system.
The fact the dollar’s share of global foreign exchange has fallen from about 72 per cent at the turn of the century to about 59 per cent, China’s currency accounts for just under 3 per cent of those reserves. Only about 2 per cent of global trade is conducted in yuan/renminbi against more than 40 per cent for the dollar. The BIS shows the dollar dominates global foreign exchange transactions with a share of almost 90 per cent and about two-thirds of all global securities issuance is in dollars.
Each financial crisis we hear of gold, and now crypto replacing the dollar. The cold reality is that there is no conventional alternative to the dollar as the world’s reserve currency. Scandals like FTX, collapses of Silicon Investment and Signature Bank, and multiple Crypto exchange frauds undermine Crypto markets. China may have ambitions to chip away at that dominance as it buys up gold and does these trade deals. It would take a revolution for the Communist Party to give up the tight control of its financial system.
Yes, the dollar’s dominance benefits the US financial sector and enables the US government and American entities such as GSEs or major corporations to borrow more cheaply than it might otherwise be able to do. Significantly it makes US non-financial businesses less competitive and has eradicated out traditional jobs as they have shifted to developing economies such as China and India. The reserve status is an increasingly exorbitant burden because of the cost of running persistent large trade deficits. The reality the US is at this time the only economy and financial system that could absorb such a large share of the world’s trade surpluses.
There is also the reality of the war with Russia has broadening to us versus them and China is on the them team. Iran for example is on that team as is North Korea, hardly bastions of freedom and security. The attitude is much along the lines of let them all trade together. China’s biggest trading partners are the US, Japan and Australia, so there is that fact that the anti US camp tends to try and gloss over.
Way down the line as various trading blocs develop in their own currencies or international digital currencies, backed by gold and other assets with low volatility, might emerge. That is the dream for many. At this time, we are a long way from a genuine alternative, clearly China d Russia, Saudi Arabia and Iran all like to gloss over Russia’s invasion of Ukraine, the rest of the world does not. Russia likes the drama, fear and trauma of destructive reconstruction of global economy and trade. Does China really want that?
China Buying Gold
China increased its gold reserves for a seventh straight month in May, signaling ongoing strong demand for gold from the world’s central banks. Central banks bought a record volume of gold last year as nations stockpiled amid rising geopolitical uncertainty, largely from Russian supporters such as China and stubborn global inflation.
China raised its gold holdings by about 16 tons in May. Total stockpiles now sit at about 2,092 tons, after adding a total of 144 tons from November through last month.
China added to its gold reserves for a sixth straight month in April, extending a flurry of purchases as central banks around the world expand their holdings of bullion amid escalating geopolitical and economic risks Singapore, China and Turkey among the biggest buyers.
China raised its gold holdings by about 8.09 tons in April, according to data from the State Administration of Foreign Exchange on Sunday. Total stockpiles now sit at about 2,076 tons, after the nation increased reserves by about 120 tons in the five months through March.
China’s recent buying spree began in November and is the first since a 10-month run that ended in September 2019. Prior to that, the last wave of inflows ended in late-2016.
China’s end-April foreign currency reserves rose to $3.2048 trillion, up by $20.9 billion from the month before, the data showed. Rise in the foreign-exchange reserves was a result of US dollar depreciation and rise in global financial asset prices, the foreign-exchange regulator said in a statement.
China Tougher Stance on Capital Flows
“China’s four big state lenders have effectively cut dollar deposit rates…, at a time when strong demand for the US currency in the banking system helped push the yuan to a six-month low. The banks have recently lowered the ceiling on the rates… for both companies and individuals… Some of the lenders’ provincial branches now offer around 5.7% on dollar deposits to their biggest clients, down from 6% previously…”
June 7 – Bloomberg
“China’s yuan jumped on Friday after the country’s central bank moved to shore up the currency following a recent selloff, vowing to curb speculation and calling for more stability in the foreign exchange market. The People’s Bank of China and the foreign exchange regulator will ‘strengthen market expectation guidance and take actions to correct pro-cyclical and one-way market behaviors when necessary.’ The offshore yuan… pulled away from 7.0750, its weakest level since December.”
May 19 – Bloomberg
“China is taking a tougher stance on capital flows out of the country as the nation’s two leading cross-border online brokerages decided to remove their trading platforms from app stores in the mainland… China has increased scrutiny of operations that could risk financial stability and national security in recent months, especially as relations with the US worsened and demand rose among mainlanders to move wealth offshore as China reopened from Covid zero. Lines at Hong Kong bank branches had hours-long waiting times in early May during the Golden Week holiday, as tourists from the mainland tried to open an account in the region.”
May 16 – Bloomberg
“China’s yuan gains for the first time this week after nearing the 7.1-per-dollar level earlier Friday. A few big Chinese state-owned banks actively sold large amounts of dollars in the onshore yuan spot market, according to several traders. At times when dollar-buying demand increased, the big banks met those bids and sold dollars, supporting the yuan, traders said; that in turn triggered selling from dollar bulls.”
May 26 – Bloomberg
“Goldman Sachs… expects more gloom for the Chinese currency despite efforts from policymakers to shore up sentiment. The US bank has slashed its projection for the onshore yuan, targeting a move to 7.1 against the dollar in the next three months… ‘Significant weakness in China data and renewed dollar strengthening on the back of progress in US debt-ceiling negotiations’ have weighed on the currency, wrote China economist Hui Shan. The onshore yuan traded 0.1% weaker Monday at 7.0241. The Chinese currency fell past the key 7-per-dollar threshold last week, the first time since December.”
May 21 – Bloomberg (Tania Chen)
Yuan Weakness
China’s yuan finished the last two-weeks of 2022 against the dollar rallying, but still had the worst annual performance in 28 years. The onshore yuan finished the domestic trading session at 6.9514 per dollar, the strongest such close since Dec. 14. It lost 8.6% against the dollar for the year.
During July the PBOC cut the 5-year loan prime rate to 4.45% from 4.6% to boost the economy and cut short term rates further this past week. Beijing warned against criticism of its dynamic zero-COVID policy. The zero-tolerance approach, which depends on strictest lockdowns and mass testing, weighed heavily on the already slowing economy and raised the need for further policy easing. Protests and further implosion of the Chinese economy led to the Chinese reversing the zero Covid policy. A monumental failure to Xi.
Looking Back at the Yuan Fall and PBoC Response
On Aug. 19, the central bank also signaled its preference for a weaker yuan by setting its daily midpoint fix for onshore trading at more than 6.80 against the dollar. This was the first time it had crossed that level in 23 months. The PBOC allows the currency to trade within a daily range of 2% up or down against the dollar from its target level. The market is asking where the upper band is now?
“China’s central bank stepped up its defense of the falling yuan with a strongly-worded statement to warn against speculation, after the currency dropped to its lowest versus the dollar since 2008. ‘Do not bet on one-way appreciation or depreciation of the yuan, as losses will definitely be incurred in the long term,’ the People’s Bank of China said… Key market participants need to ‘voluntarily safeguard the stability of the market and be firm when they need to iron out big rallies or declines in the exchange rate.’ The central bank added that it has ‘plenty of experience’ to fend off external shocks and effectively guide market expectations.” September 28 – Bloomberg
The forward margin between the Yuan and the USD widened as the PBoC’s rate cuts have been made it less attractive to hold the yuan against the dollar because the U.S. Federal Reserve has gone in the opposite direction.
April 28 – Bloomberg (Sofia Horta e Costa and Tania Chen): “When China’s tightly managed currency depreciates dramatically against the dollar, it can be hard to stop. More than six years after China’s shock 2015 devaluation roiled global markets and spurred an estimated $1 trillion in capital flight, the yuan is weakening at a similar pace. Onshore it’s lost nearly 4% in eight days, while the offshore rate is heading for its worst month relative to the greenback in history. Selling momentum is the strongest since the height of Donald Trump’s trade war in 2018.”
China Foreign Exchange Trading System
While the yuan has tumbled about 8% versus the USD in2022, it has strengthened against the currencies of major China’s export rivals such as Japan and South Korea. The yuan’s trade-weighted basket is just about where it was at the end of December.
The Fed’s tightening cycle has triggered a widespread selloff in Asian currencies this year, including more than 10% declines for the Japanese yen and the Korean won. China’s central bank last let the yuan depreciate past 7 to the dollar in August 2019, during the trade war between Beijing and Washington.
The yuan however has held up better against other currencies this year. China Foreign Exchange Trading System, an arm of the central bank, measures the performance of the currency against a basket of 24 currencies, including the dollar, yen and euro and lesser-traded currencies such as Polish zloty and Russian ruble the WSJ reported. That yuan index was roughly at the same level it was at the start of 2022, according to the most recent data published on Aug. 19.
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From The TradersCommunity Research Desk