If China, and others, needed a wake-up call that was it. It would have been immediately obvious to China that it would be hit with the same sanctions should it want to progress its ambitions towards Taiwan.

It’s not just the brutal demonstration of the power the role the dollar plays within the global financial system or its own ambition of challenging US hegemony that would provide motivation for China to try to promote its own currency.

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The dollar’s centrality within the global economy means that US economic and monetary policies also play an outsized role in the global economy. The Federal Reserve’s decisions on interest rates and the availability of credit have flow-on effects to other economies and financial systems.

With the Fed now raising rates and withdrawing liquidity from the US economy, even as China is trying to stimulate its flagging growth rate, a divergence of monetary policies and interest rates is occurring that, with capital already flowing out of China towards the rising rates in the US, has the potential to override China’s policies and destabilise its economy, or at least force it to take decisions it would otherwise not have made.

That’s not a comfortable position, particularly for a country with its own hegemonic ambitions.
China had already taken some small steps to putting in place the foundations for positioning the yuan as a meaningful alternative to the dollar.

For well over a decade it has been negotiating currency swap deals with other central banks to facilitate the direct use of its currency in trade that more commonly is denominated in US dollars.

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It created its own version of SWIFT, the Cross-Border Interbank Payment System, in 2015 to facilitate cross-border renminbi-denominated trade settlements, lobbied successfully to have the yuan included in the International Monetary Fund’s Special Drawing Rights basket of currency reserves and, more recently, developed a digital version of its currency.

It has been piloting yuan-denominated oil deals with Saudi Arabia, trying to negotiate iron ore purchases in yuan and, more recently, for obvious reasons, has been settling deals with Russia in yuan and roubles.

Despite those efforts, the yuan is still only used in just over two per cent of global payments. The US dollar is used in about 42 per cent of global payments. It is the currency for nearly three-quarters of trade in the Asia-Pacific. Two-thirds of global securities issuance is in dollars and about 60 per cent of foreign exchange reserves.

China is slowly putting together the architecture, infrastructure and relationships to build, not a global challenger to US dollar primacy at this stage, but a regional one.

It’s taking a long and incremental approach to its ambitions for the yuan and its own financial security and is focusing on its sphere of interest in the Asia-Pacific and the developing economies where its Belt and Road program provide it with both influence and leverage. A number of African countries, for instance, have begun settling payments in yuan and holding yuan within their currency reserves.

China wants to promote the yuan as a new anchor currency in Asia and other small regional blocs with no great affection for US dollar dominance. Its efforts can only have intensified after the demonstration of the dollar’s hegemony in the American response to the invasion of Ukraine.

Its ambitions are necessarily constrained by its own system and the Communist Party’s obsession with control over every aspect of its society and economy.

The dollar’s role in the global economy and financial system flows from the depth and liquidity of its financial markets, the strength of the regulation of those markets, the transparency of its judicial system, the size of its economy and fact that its central bank is at arms’ length from its political class. The currency is freely floating and fully and readily convertible.

China doesn’t have fully developed financial markets. It has capital controls. The yuan isn’t free-floating or fully convertible and isn’t driven primarily by market forces. Its regulation and judicial systems are opaque and untrusted by Westerners. The PBOC will do what the party directs.

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Some of those things might be changeable at the margin – China has been trying to open up its financial markets – but more complete liberalisation is inconceivable and therefore China’s international ambitions for the yuan are constrained by its domestic policies and priorities.

At this point it is seeking to shave slivers off dollar dominance and fragment it over time rather than displace it. China does, of course, take a long view of history.

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