By Dr Dan Steinbock
Dr Dan Steinbock is an internationally recognised strategist of the multipolar world and the founder of Difference Group. He has served as Research Director at the India, China and America Institute (USA) and Visiting Fellow at the Shanghai Institutes for International Studies (China) and the EU Centre (Singapore).
According to SWIFT, the US dollar still accounts for 39% of international payments, as opposed to the Euro (33%), the English pound (7%), Japanese yen (3%) and Chinese yuan (28%). However, times are changing.
New developments on the global stage
In October, China established a payment versus payment (PVP) system for transactions involving Chinese yuan and Russian rouble. The China Foreign Exchange Trade System (CFETS) hopes to launch similar systems with other currencies based on China’s huge multi-decade, multi-trillion One Belt One Road (OBOR) initiatives. While the OBOR will expand links between major economies in Asia, Africa, Europe and Latin America, many member countries are possible candidates for yuan-denominated payment transactions.
In December, Iran announced it would join the Russia-led Eurasian Economic Union (EEU) in early 2018. It has not deployed US dollar in foreign-trade transactions since the early 2010s. The EEU is also likely to have a central role in the OBOR, and thus in future yuan-denominated transaction systems.
Rise and eclipse of petrodollar
After the 1945 Yalta Conference, which effectively divided Europe, the ailing President Franklin D. Roosevelt met Saudi Arabia’s King Ibn Saud. Bypassing the Brits, FDR and Saud agreed to a secret deal, which required Washington to provide Saudi Arabia military security in exchange for secure access to supplies of oil.
Despite periodic pressures, the pact survived for a quarter of a century until the 1971 “Nixon Shock.” As the dire US economic prospects led President Nixon towards the unilateral cancellation of the direct international convertibility of the US dollar to gold, the post-war Bretton Woods system of international financial exchange was replaced by a regime based on freely floating fiat currencies.
To deter the marginalisation of US dollar, Nixon negotiated another deal, which ensured that Saudi Arabia would denominate all future oil sales in dollars, in exchange for US arms and protection. As other OPEC countries agreed to similar deals, global demand for US dollars—the “petrodollars”—soared.
The US-Saudi strategic partnership weathered seven decades of multiple regional wars. When the Fed began to pave way for rate hikes in 2014, the value of the dollar started to climb, though more slowly than expected. Oil prices plunged and are likely to stay relatively subdued for a protracted period. Nevertheless, President Trump signed a historic $110 billion arms deal with Saudi Arabia.
Ironically, the oil markets remain priced in a currency that is burdened by debt and overstretching.
Rise of the petroyuan
In the west, Chinese efforts are often portrayed as Beijing’s game to undermine the dollar’s global dominance. Yet, it is not in the interest of China to debunk the value of its US Treasuries, which are held in US dollars and still amount to $1.1 trillion. On the other hand, as the world’s leading oil importer, Chinese currency should have a central role in oil pricing.
Since 2012, China has hoped to price oil in yuan using gold-backed futures contracts in Shanghai. Yet, implementation depends on policymakers’ balancing act between market stability—which has been seen as vital since the 2015 market volatility—and internationalisation. The latter would require reduced capital controls and intervention, and is needed to attract overseas oil traders and producers.
Many of China’s major oil suppliers in Russia, Middle East and Asia already accept the yuan in payment transactions. Russia, Iraq, Indonesia and other countries, many of which play a vital role in the OBOR initiatives, have joined in non-dollar trades. Oman, too, has a role in the plan, as evidenced by the Chinese contractors who are turning the dusty fishing village Duqm into a $10.7 billion Sino-Oman Industrial City.
If Saudi Arabia decides to adopt the yuan for some of its oil exports, that would serve as a catalyst for a broader shift. Additionally, if major Chinese players will participate in Aramco’s initial public offering—a deal in which Hong Kong could serve as a venue for 5% stake ($100 billion)—that could sway Saudi views even further toward yuan.
As long as Washington, at least officially, supported global engagement, the US dollar was sustained by America’s international alliances. With Trump’s “America First” stance, that era is fading. Pakistan is a case in point. When the White House suspended US aid to Pakistan, Islamabad announced that the Chinese yuan can be used for bilateral trade and investment activities. The latter will support the proposed Chinese-Pakistan $57 billion economic corridor which is yet another OBOR pillar.
A gradual, accumulative shift in store
US dollar’s coverage is slipping because structural conditions that supported its dominance have been softening since 1971. As long as emerging and developing economies depend on the US dollar, they remain exposed to US currency risk, US sovereign debt (which now accounts more than 106% of the US GDP), not to speak of the fluctuating politics of US sanctions regimes. The recent U.S. government shutdown is a reminder of its structural fragility.
What we are witnessing is not an overnight effort to replace US dollar with Chinese yuan in international transactions, but a progressive shift to deploy yuan in those transactions in which the Chinese economy plays a central role.
This shift is gradual, linear and accumulative. Today, global currency diversification is vital because an overconcentration of foreign assets denominated in the dollar could bring huge collateral damage.
However, if investors one day lose faith in the US dollar—maybe due to a US debt crisis, a huge Trump policy blunder, a divisive bipartisan struggle for the White House, or yet another military overstretch—the shift away from US dollar could turn disruptive, accelerative, and geometric.
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