The ubiquitous use of the US dollar in international financial institutions, trade deals and foreign exchange transactions has proved to be a considerable source of US power within international relations and the global economy. Indeed, a recent survey administered by the Bank of International Settlements found that 87 percent of foreign exchange deals conducted throughout the world utilized the US dollar. Many countries also hold substantial foreign reserves in dollars; including China, in which US dollars account for around 60 percent of its foreign reserve portfolio, and Russia, who holds reserves of around 80-90 billion in US dollars.
For over 70 years, the position of the dollar as the international standard has afforded the US many competitive advantages over other major players within the global economy. As French financial analyst, Pierre Lecomte, observed, “while the rest of the world must toil hard to earn dollars which are needed to buy goods internationally or to pay off foreign debt, the US just needs to print dollars”.
Additionally, the dollar as the world’s reserve currency enables the US to borrow at lower rates than it could otherwise, and there is substantial convenience value in the ability of US financial institutions and firms to conduct transnational trade using their own currency.
Countries are also loath to allow their currency to depreciate or appreciate too heavily against the dollar as fluctuations in exchange rates will have repercussions on both domestic inflation and international competitiveness; due to the majority of international trade being denominated in dollars.
Recently, however, the dollar’s position in the global economy has been contested by the actions of Beijing and Moscow.
Recent Efforts of China and Russia
With a notable increase in cooperation between Beijing and Moscow in many facets of trade, security and politics, it should come as no surprise that there has been an orchestrated attempt by these two nations to reduce the influence of the dollar in both the global economy and within their respective domestic economies.
In October 2014, the central banks of Russia and China signed a 3 year currency swap agreement worth around $20 billion US that denominates trade between the two countries in yuan and rubles. This agreement will expedite trade deals between Russia and China, reducing both the influence of the dollar in regional trade transactions and the risks of currency exchange fluctuations.
Recently, China has replaced the dollar with the Russian ruble as the secondary currency in the Sino-Russian border town of Suifenhe City; and Russia has switched many state-run institutions, banks and energy companies from the dollar to the yuan. For example, two state energy companies, Gazprom and Gazprom Neft, have committed to using more yuan in trade, and Russia’s largest bank, Sberbank, has advocated and utilized the yuan to an unprecedented extent.
In late November, Russia’s central bank added the yuan as a reserve currency, and President Putin has also urged for legislation that will eliminate the euro and dollar in trade deals between Russia and former Soviet states, such as Kazakhstan and Azerbaijan.
In perhaps the most significant move by Russia and China, both countries have sold considerable amounts of their US dollar foreign reserves. China once held $1.3 trillion in US debt; however, in August, $93.9 billion of this debt was sold. Similarly, Russia recently unloaded 20 percent of its US debt holdings. This was an effort to bolster the yuan and ruble, decrease the influence of the dollar in the domestic economies of Russia and China, and can be perceived as an attempt to destabilize the dollar’s hegemonic position.
Why has there been an increase in financial cooperation?
The United States has often employed the use of financial incentives and penalties as diplomatic tools of coercion to change the behavior of misbehaving states, i.e. “the weaponization of finance”. This is evidenced by the sanctions on Cuba, Iran and, most recently, Russia.
Subsequent to Russia’s annexation of Crimea, the US and EU implemented sanctions targeting Russian officials, banks and corporations. Much of Russia’s recently increased financial cooperation with China stems from these sanctions.
Russian access to many western financial institutions was effectively cut off. As such, Russia was forced to diversify its financial dealings and China, as the world’s second largest economy, provided much needed relief.
Russia has also contested US dominance in the global economy since the implementation of the Bretton Woods system in the mid-20th century. Thus, it is unsurprising that Russia seeks increased financial cooperation with China in opposition to US dominance.
Beijing, on the other hand, has its own motivations for financial cooperation with Russia.
China has shown a desire for involvement in the world’s financial institutions since its economic opening beginning in 1979. Throughout the late 1980s and 1990s China applied for ascension into the World Trade Organization (WTO) and was consistently denied. Consequently, China engaged in the rapid reform of its economic system, transitioning to a socialist market economy and re-aligning many of its domestic policies with international standards. In 2001, China achieved WTO ascension. The years since have seen an unprecedented rate of growth in China’s economy.
Similarly, for the past two years China has lobbied to be included in the International Monetary Fund’s basket of top world currencies that make up the IMFs “special drawing rights’- a supplementary currency for international transactions whose value is based on this basket of reserve currencies. This request was denied until November 30. Subsequent to numerous financial reforms in the Chinese economy, IMF President Christine Lagarde and the executive board have decided to include China in this basket, which has provided the yuan considerable prestige within the global economy. This is an arguably symbolic gesture, however, it does show the potential for the yuan in international markets and the commitment of the Chinese government to continue financial reforms.
Both China’s ascension to the WTO and the yuan’s inclusion in the IMFs top world currencies shows China’s intent: more participation and influence in the current economic world order.
China has implemented reforms that adhere to international standards with the goal of admittance in such organizations as mentioned above. China’s recent global financial and economic efforts, such as the formation of its Asian Infrastructure and Investment Bank (AIIB), a push for an Asia-Pacific Free Trade Area (FTAAP) and its involvement in BRICs, are not intended to displace the US as hegemon, but only to garner more influence and respect within the current system. Financial cooperation with Russia is another means to acquire this influence.
China and Russia partnering to contest the dollar is convenient for Beijing as it allows China to move beyond the scope of US influence in its international dealings. The currency agreements between Russia and China effectively eliminate the dollar from regional trade transactions and show Washington that it is possible to conduct international trade deals and financial transactions outside the current system. This forces the US to take China and its institutions seriously. Thus, for China, Russia is leverage.
The Dollar Remains King
Investor confidence is perhaps one of the most crucial factors of a currencies position in global markets. The dollar has been cemented as the international standard due largely to the perception of the United States and its financial markets as stable and relatively safe. Thus, confidence in the dollar has generally remained high.
Moreover, as it currently stands, there is no viable alternative to the dollar.
The Euro was a major contender for the position in the early 2000s. However, despite the widespread use of the Euro as a reserve currency, investor confidence has never reached the levels of the dollar. The recent developments in the Greek debt crisis has shown the fragility and risks of the Euro zone and its primary currency, which further decreased investor confidence in EU financial institutions.
There are numerous other reserve currencies, such as the Japanese yen, Swiss franc, pound sterling and Canadian dollar that have experienced widespread utilization in global financial markets. However, none have been successful in garnering the confidence experienced by the US dollar. The Chinese yuan is no exception and has arguably generated less confidence from investors than any of the above currencies.
Due to China’s political and economic system, there is little transparency in Chinese financial institutions. This proves to be a considerable deterrent for investors.
Financial markets in China are also subject to much more government intervention than those in the West. Recently, Chinese stock markets experienced considerable investor flight. In response, the Chinese government locked down nearly 70 percent of equity markets to prevent the selling of Chinese stocks. This is a far cry from what global investors are accustomed to in Western markets and proves to be another deterrent for investment in Chinese markets.
In August, China devalued the yuan by 2 percent, the biggest devaluation of its currency in 20 years, to bolster exports and revitalize the slumping economy.
The extent of government intervention in financial markets, as evidenced above, greatly reduces confidence in the yuan as a reserve currency.
The ruble has even less sway in international markets, however, it has not been Russia’s goal to replace the dollar with the ruble; only to limit the dollars influence in regional and global trade.
The efforts of China and Russia have been relatively successful in this as the bilateral trade and currency agreements between the two countries have displayed an ability to work outside the dollars influence. This will certainly add further multipolarity to the global economy and may motivate additional countries to adopt similar bilateral trade deals in an attempt to work outside the current international currency standard.
Nonetheless, the opaque nature of the political and economic systems in Russia and China render their currencies poor replacements for the US dollar as the international currency standard. Confidence remains high in the dollar and despite the recent reforms in the Chinese economy, it will be many years before confidence is high enough in the yuan for it to replace the dollar as the reigning king.