Beijing knew it could not make “Yuan” (Renminbi) an internationalized currency overnight, nor could it replace the U.S. dollar’s dominance in the global system with the Chinese currency. China has US$3.0549 trillion in foreign exchange reserves (end of August) – the largest in the world. About a third – US$1 trillion – of its foreign reserves are in U.S. Treasuries.

 

China is the second-largest foreign holder of US government debt, after Japan. However, Treasury department data showed that the Chinese government has slashed holdings of U.S. Treasuries for a seventh consecutive month in June. China’s stash of U.S. debt dropped to US$967.8 billion in June, the lowest since May 2010 when it held US$843.7 billion.

 

Interestingly, last week, China’s central bank – People’s Bank of China – has asked major state-run banks to get prepared to sell dollars and stock up yuan. On paper, it appears to be efforts to arrest Yuan’s depreciation against the greenback. After all, the Chinese currency has lost close to 12% against the dollar so far this year, thanks to aggressive interest rate hikes by the U.S. Federal Reserve.

Strangely though, unlike other countries that scrambled to increase interest rates in order to narrow the gap, China did the opposite – cutting rates to spark economic growth. Was it a coincidence that the world’s second largest economy quietly sells its U.S. denominated debt papers for 7 months in a row as well as cutting interest rates, which weakens the Yuan instead of strengthening the Chinese currency?

 

It’s a fantastic opportunity to reduce its huge foreign reserves, especially its U.S. Treasuries. Selling at a time when the U.S. dollar is fetching a high price is smart. And it’s even smarter to minimize exposure to the greenback, so that what had happened to Russia when its foreign reserves of US$630 billion were frozen after the invasion of Ukraine would not happen to China.

 

China’s central bank has also fixed the initial value of the Yuan at 7.0298 to the dollar for the first time in more than two years. Allowing the psychological barrier – 7 Yuan To US$1 – to be breached and changing regulation to discourage trading against the currency means Beijing does not want to try to defend any particular foreign exchange level, but to slow the pace of depreciation.

While a weaker Yuan makes China’s exports cheaper, particularly in the U.S., it also makes American exports more costly in foreign countries like China. But thanks to “Zero Covid” policies, including the lockdowns of large cities, demand for imports in China have crippled – keeping inflation in check. There’s a theory that the lockdown was purposely designed to create supply-chain disruptions, creating inflation for the U.S.

 

Part of the reason not to control the long-term value of the Yuan is to make the currency more international. According to the latest IMF report, the Chinese Yuan accounted for 2.88% of global foreign currency reserves in the second quarter of 2022. This might not sound a lot, but in August 2022, the export and import of China’s international trade totalled RMB 4.0265 trillion – up 9% over the same period last year.

 

China might not be able to dethrone the U.S. dollar dominance, but it can certainly de-dollarize the greenback by taking baby steps in increasing trade in Yuan. For example, China offers massive discount to Indian businesses if they settle their transactions in Yuan. India’s steel and cement companies have benefitted mostly – as much as 15% discount from the Chinese offer.

Indian Rupee has depreciated 9% against the U.S. dollar, but the currency exchange between Indian Rupee and Chinese Yuan has changed only 2% year-to-date. With 15% discount thrown in, the Chinese offer was indeed very attractive. Already, India’s biggest cement producer, UltraTech Cement, has imported over 157,000 tonnes of Russian coal in June, and was paid using Chinese Yuan and Hong Kong dollar.

 

Yes, it was quite extraordinary that India and Russia trade with each other, but is using China’s currency to settle their transactions. Meaning they are dumping the U.S. dollar as the currency of commerce. This makes perfect sense because in the context of India-Russia-China trade, it has nothing to do with America. It also reduces risk to potential U.S. sanctions.

 

India, the second-most populous country and the “most populous democracy” in the world, is a member of five major emerging economies – BRICS – comprises Brazil, Russia, India, China and South Africa. At the same time, India has annoyed the Western powers for refusing to condemn Russia’s invasion of Ukraine, and the recent annexation of the Ukrainian regions of Donetsk, Luhansk, Kherson and Zaporizhzhia.

More importantly, the transactions highlight how India has maintained trade ties with Russia for commodities such as oil and coal despite the western sanctions. The increasing use of Yuan to settle payments also helps insulate Moscow from the effects of US-led sanctions imposed on Russia over its invasion of Ukraine, and further internationalise the Chinese currency in global trade.

 

Crucially, Yuan has not dropped as sharply against the U.S. dollar as have the Euro, the Yen, the Pound and other major currencies. In fact, against a basket of currencies of China’s main trading partners, Yuan has fallen just 1.4% year-to-date. This indicates that the Chinese currency is “stable” in time of crisis – an incentive for other countries to spread their risks to park in Yuan.

 

The best part is the Western-controlled SWIFT network or gateway system is not involved in the trade settlement in Yuan. This means those transactions cannot be monitored by the U.S. government, and if they can’t be tracked, the U.S. won’t know if sanctions have been breached. The SWIFT system can no longer be used as the ultimate political weapon to punish U.S. rivals.

On September 12, Russian President Vladimir Putin said that the economic sanctions mean it’s only a matter of time before the full “de-dollarization” of the Russian economy. Russian giants, including Rosneft, Rusal, Polus and Metalloinvest, have dramatically increased their investments in Yuan bonds. But the diversification from dollar does not involve only the Chinese currency.

 

Moscow is asking for payments to be settled in UAE Dirham from Indian oil refiners and coal importers. Turkey agreed to pay for Russian gas supplies partially in rubles. Indonesia is seriously considering Russian oil that is 30% cheaper compared to the global oil, most likely to be paid in currency other than dollar, euro, pound or yen.

 

Even American allies like Egypt, having suffered greatly due to the cost of servicing dollar-denominated debt, has issued Yuan-denominated debt to raise funds in the Chinese bond market for the first time. Other payment systems like China’s UnionPay, which connects 55 million merchants in 180 countries, including 37 million merchants located outside of China, is also chipping away the dominance of the U.S. dollar.

However, something is brewing in China that has evaded the world’s mainstream media so far – China has been quietly importing “GOLD” from Switzerland at a record rate. The Swiss gold export to China in July rose to its highest since December 2016. According to Reuters, China gobbled 80.1 tonnes of gold (worth US$4.6 billion) – a monthly increase of 146% from a mere 32.5 tonnes in June, before slowing in August.

 

One of the reasons Beijing is stockpiling gold reserves could be to peg the Yuan, the same way Putin cleverly pegged the Russian currency to gold in order to stabilize the ruble. Unless China is ready to invade Taiwan, the U.S. hegemony might crumble if China, the world’s second-largest economy, links yuan to gold. Between a Chinese Yuan that can be converted to gold and a US dollar that can’t, the choice is obvious.

 

On March 25, the Bank of Russia unexpectedly announced that it would link ruble to gold at 5,000 rubles per gram. By pegging the currency to gold, Putin has effectively strengthened the ruble with a gold standard. Meaning he has set a floor price for the ruble in terms of the U.S. dollar since gold trades in U.S. dollar. Today, the “Ruble” is 60.40 to a dollar (it plunged to record low of 151 on March 7).

Currently, almost all countries in the world are – blindly – pegging their currency with the U.S. dollar, which is actually worthless because the U.S. has just crossed “US$31 trillion in federal debt” and the dollar isn’t pegged to gold. If other nations started to peg their currency with gold-pegged Yuan, this could accelerate the de-dollarization as the USD will lose its status as a safe haven.

 

China’s foreign exchange reserves stood at US$3.25 trillion at the end of December, 2021. However, it plunged to US$3.054 trillion in August 2022 – suggesting that not only the Chinese government has reduced its reserves to the tune of US$200 billion, but might have dumped the U.S. Treasury in exchange for gold. The gold standard represents a world financial order.

 

But does China have enough gold for a gold standard? The United States is supposed to have the world’s largest gold reserve – more than 8,000 metric tons of gold. However, nobody knows whether the U.S. really has those physical gold. On the other hand, China is the world’s largest producer of gold. The Shanghai Gold Exchange actually trades primarily in “physical metal”, allowing delivery of physical gold.

At the end of 2021, the total amount of physical gold withdrawals from the Shanghai Gold Exchange was 21,704 tonnes, roughly 690 million ounces. To put that in perspective, global gold production was approximately 113 million ounces last year. China doesn’t sell gold, and also does not export domestic mine production, meaning it has more gold reserves than reported (1,948 metric tons – end of 2021).

 

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October 5th, 2022 by financetwitter

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