The global financial system is changing – is the Chinese yuan making inroads in international trade?

While most of the world’s attention last year was focused on inflation developments and geopolitical events, tectonic movements in the global financial system were unfolding in the background. The Chinese yuan, which in 2010 accounted for only 0.1% of global financial transactions, is gaining momentum due to the global trade and geopolitical realignment accelerated by the war in Ukraine. Indeed, according to data by SWIFT, the world’s leading interbank payment system, the yuan had overtaken the Japanese yen, the world’s fourth most important currency, by November.

Given that the SWIFT data systematically underestimate the weight of the yuan in world trade (SWIFT’s figures do not include transactions of its smaller-turnover rivals, which are mainly used in Eurasia), we can make the assumption that the Chinese yuan’s share of world trade (4.6%) is now actually very close to that of the British pound (7%), the third most used currency in the world. The yuan already ranks second in trade transaction finance, ahead of the euro. Although the dollar is still by far the most important currency in world trade (accounting for almost 50% of transactions and around 40% of trade finance), all of this raises the question: is the global financial system in transition and if so, what form will this transition take?

The figure can be referenced here:

The figure can be referenced here:

The development starkly divides currency market experts, with some predicting the imminent collapse of today’s dollar-based global financial system, with far-reaching consequences for world trade and financial markets. Others say there is nothing to see: the dollar’s dominance remains unchanged, with a surge only in yuan-based trade between countries already opposed to the United States, most notably Russia, which is under financial siege from sanctions.

To see clearly amidst the often contradictory commentary, it is worth briefly recalling what has happened in the foreign exchange markets since 2022 and, equally important, what has not.

What has happened:

  • The West has imposed sanctions of unprecedented levels and depths on Russia to force it to give up the war in Ukraine by crushing its economy. Most importantly in this case, Russia has been excluded from the Western-led financial system (including SWIFT, which plays a crucial role in bank-to-bank communication) with a few exceptions, and has been overwhelmingly banned from Western markets in terms of key products (energy carriers, raw materials, machinery and electronics.)
  • These could indeed have caused catastrophic damage to the Russian economy if China had not come to the aid of its partner and bought up Russian energy carriers and raw materials instead of the West, in exchange for the Chinese equivalents of the missing Western products (or the Western products themselves, through intermediaries). However, this trade is of course entirely yuan-based. While 3% of Russian foreign trade was in yuan in 2021, this figure is now 75%. China has effectively moved Russia into its own financial system, CIPS, which is a rival of SWIFT, and is explicitly encouraging Eurasian governments to use CIPS. It is building an entirely new, Beijing-centred financial bloc. Recently, for example, Bangladesh started paying Russia in yuan for its nuclear power plant, which is being built using Russian technology, through CIPS. Although the turnover of CIPS is still a fraction of that of the Western-run SWIFT, the consequences are already far-reaching: in 2023, for the first time, the yuan became China’s most important foreign trade currency, replacing the dollar(!).
  • The West froze $300 billion in Russian financial assets after the Russian attack began, and is currently discussing – with heated debate – its confiscation. This is in fact a very dangerous game, especially for the West: while the West claims to be defending a rules-based world, the confiscation of assets is completely against international law, since neither the US nor the EU is a belligerent. On this basis, after the Western invasion of Iraq, China or Russia could have confiscated Western financial assets on their own territory. Of course, this is not to say that the two situations or the actors are morally comparable. However, legal certainty is disappearing from behind the dollar-based system, and such a precedent gives the countries of the global South a powerful incentive to decouple, at least in part, from the Western financial system. The American Nobel Prize-winning economist Robert Shiller has described the idea of confiscating Russian financial assets, which have as yet only been made inaccessible, as a ‘catastrophic’ and wrong move that would end the dollar system – moreover, at a time when the US national debt is over $34 trillion and growing unstoppably, therefore foreign investor confidence is definitely needed. (Some $200 billion of the $300 billion in Russian assets are held in the EU’s Euroclear system, so the move would not only damage the US’s image.)
  • In addition to China, India, which has traditionally had good relations with Russia, has also helped Moscow and bought large quantities of Russian raw materials, especially oil. (This was also exceptionally advantageous for India, since it got access to cheap oil, essential for its growth, at depressed prices due to the sanctions.) Moreover, the whole BRICS and its future members have also started to actively engage in a move away from the dollar (instead of the mainly communication campaigns of the past): the United Arab Emirates sold oil to India in rupees, Brazil sold agricultural products to China in yuan, and Saudi Arabia and China multiplied the use of the yuan in trade between each other in a $7 billion currency swap deal. This has meant, for example, that in 2023, for the first time since the end of the world war, 20% of global oil trade was not in dollars.

But what has not happened?

  • The spectacular rise of the yuan and the trade settlement between BRICS members is far from smooth. It is not just that the international banking system is essentially Western and dollar-based: the trading countries themselves often can’t do much with each other’s currencies when one of them systematically runs a trade surplus. (Remember, at present neither the Chinese yuan nor the Indian rupee is a freely convertible currency! And the flow of capital between China and the outside world is, to put it mildly, not free; it’s practically at Beijing’s discretion.) This is what happened to the Russians in their trade with India when they were so unable to use the rupee accumulated in Indian banks that they ended up having to bring in a series of third, intermediary currencies, such as the Hong Kong dollar, to their trade as a temporary solution. For similar reasons, the development of Brazil-China yuan-based trade, for example, has also been difficult.
  • None of the BRICS members is eligible or aspires to have its currency as a reserve currency. According to IMF data, the world’s central banks, almost unchanged, hold 59% of their financial reserves in dollars, 20% in euros, and a smaller proportion in Japanese yen and Swiss francs. In addition to the lack of convertibility and free movement of capital, the yuan would also find it difficult to become a reserve currency because Beijing already uses the yuan as a tool of foreign policy: we need only recall that when the anti-China Milei recently won the Argentine elections, Beijing immediately froze yuan (currency exchange-based) financing, which is critical to the Argentine economy. In other words, the dollar is not the only reserve currency that can become a foreign policy blackmail weapon. In any case, the BRICS members, and China in particular, have significantly reduced their holdings of US Treasuries and are increasing their purchases of gold, also in a bid to become dollar-independent. It is not difficult to predict that the next geopolitical or global financial crisis will force the creation of a non-dollar based international clearing and reserve unit (this could also be gold or a digital, commodity-based reserve currency). For the time being, however, there is no alternative in this respect; the dollar can currently only be replaced, not substituted.

The dollar remains the number one currency for trading and conversions in international currency markets, i.e. for companies, investment and pension funds, and hedge funds. In half to two-thirds of all transactions in the foreign exchange market (not to be confused with international trade), the dollar is on one side of the deal. Here too, however, it is worth noting the growing weight – lagging behind its economic strength – of Asia. To take just one example, 70% of new securities accounts at the largest US online brokerage firms are now opened by Asian clients, and Western stockbroking is increasingly forced to adapt to Asian clients, for example in terms of night-time opening hours.

Overall, then, what we are seeing now as the yuan’s advance is a kind of violent symptomatic reaction to the events of 2022, rather than a systemic change. Systemic change will, however, be inevitable over time if geopolitical bloc formation and the restructuring of global trade continue at this pace: China’s number one trading partner is now no longer the West but the global South. As this process progresses, the dollar-based global financial system in its current form will not be sustainable in the long term.

The figure can be referenced here:

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