Opinion
The US dollar is making a comeback at China’s expense
Stephen Bartholomeusz
Senior business columnistThe demise of the US dollar has been predicted so often it has been taken as an established truth. And it may or may not be true in the long term – but for now, the greenback is back in favour.
A survey by UK think tank the Official Monetary and Financial Institutions Forum of 73 central banks with $US5.4 trillion ($8.1 trillion) in reserves has found that a net 18 per cent of them plan to increase their asset allocation to the US dollar over the next 12 months to two years. That’s tripled from a year ago, when only 6 per cent planned to increase their dollar holdings.
Out of China’s renminbi, buy into US dollars: The greenback is back in favour.Credit: Aly Song
A net 7 per cent also plan to increase their holdings of the euro, signalling a clear shift towards the traditional reserve currencies, according to the survey released this week.
Conversely, about 12 per cent of the central banks’ reserves managers want to reduce their allocations to China’s renminbi over the next two years, with only 2 per cent planning to stock up. Last year, a net 10 per cent of them said they would increase their renminbi holdings and, in 2021 and 2022, more than 30 per cent of them planned to allocate more to the Chinese currency.
Central banks’ holdings of US dollars have waned over time – the greenback accounted for about 70 per cent of central bank reserves in 2020 whereas today, after a slow but steady decline, it constitutes about 58 per cent of the roughly $US15 trillion of assets they have invested in – so the findings of the survey represent something of a reversal of the long-term trend.
Similarly, the renminbi’s appeal had been rising over time, with China going to great lengths to improve its attraction as a reserve currency.
It has promoted its usage in trade, investment and development finance, created renminbi-based regional payment and commodity trading systems, and has been using its own currency to trade with Russia and the Middle Eastern oil producers.
China is pursuing a two-pronged strategy. It wants to reduce its own vulnerability to the dollar dominance and the power it confers on the US, which has used its grip on the global financial system to impose powerful sanctions, the most significant of which was the freezing of the more than $US300 billion of Russia’s central bank reserves held offshore after Russia invaded Ukraine.
Chinese companies and individuals have also been sanctioned by the US. In 2020, Carrie Lam, Hong Kong’s chief executive at the time, said she was forced to keep “piles of cash” at home as US sanctions over Hong Kong’s then-new security laws completely cut off her access to banks.
It’s not just China and Russia that were perturbed by the freezing of Russia’s reserves. The BRICS+ grouping of China, Russia, developing economies and some Middle Eastern economies have all been unsettled and are trying to develop strategies to reduce their US-dollar-generated vulnerabilities.
The reason for the dollar’s bounceback and the renminbi’s reduced appeal relates to macroeconomics as much as it does to geopolitics.
That might explain why, even as they plan to lift their allocations to the greenback over the next two years, their central banks expect to reduce the dollar’s share of their reserves over the next decade and increase their allocations to the renminbi. It’s the first time the survey has produced results showing a decline in the renminbi allocation.
The central banks surveyed expect a “very gradual” decline in the dollar’s share of their reserves over the next 10 years, from about 58 per cent to an average of 55 per cent, while lifting the renminbi’s share from 2.3 per cent to a still modest 5.5 per cent.
To put that in context, about 20 per cent of central bank reserves are allocated to euros and about 11 per cent to gold. It is going to take many decades - if the long-term trends were to resume - for the dominance of the dollar to be eroded, let alone be superseded by the renminbi.
The banks’ allocation to gold, incidentally, has been surging. Gold represented 9 per cent of their reserves a year ago and, despite it trading at record prices, a net 15 per cent of the reserves managers expect to increase their allocation to gold over the next two years. That, according to the survey, would mean buying a further $US600 billion worth of gold.
The dollar’s bounceback and the renminbi’s reduced appeal are due to macroeconomics as much as they are to geopolitics.
The US dollar has been strong over the past year, thanks to the strong (albeit now fading) growth in the world’s largest economy and, with US inflation levels still relatively high (albeit declining), the level of US interest rates. In contrast, China’s growth has been, by its standards, weak and bumpy; its interest rates have been falling, and its currency has been depreciating.
Two-year US Treasury bonds yield 4.77 per cent and 10-year bonds 4.34 per cent. China’s 2-year bond rate is 1.75 per cent and its 10-year bonds yield 2.3 per cent. It’s not surprising that central banks are chasing the higher returns.
Geopolitics – the increased tensions and trade restrictions between the US and China and, more recently, the European Union and China – may also be playing a role. The survey showed that, after inflation, geopolitics was the second-most important factor in their investment decision-making over the next two years.
Inflation is obviously the major concern for central bankers in the post-pandemic environment, where inflation rates in the major economies surged to levels not experienced for decades.
A year ago, more than half the reserves managers surveyed expected inflation to remain above 4 per cent. The latest survey shows that central banks expect the rates in the major economies to be within 2 to 4 per cent. Most of them target the lower to middle level of that range, so the survey shows the central banks believe they have almost, but not quite, regained control of inflation.
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