Why China’s goal of ending US dollar dominance is still decades away
- Recent efforts with Saudi Arabia and Brazil to promote use of local currencies are indicative of China’s goal of ending US dollar dominance, but the structure of global trade and financial transactions mean achieving that goal could still be well down the road
While the level of intent and official support could move the dial more than before, the structure of trade and financial transactions means this transition towards a more multilateral currency regime could still be decades away.
Not only are China’s trade partners advocating a greater use of their own currencies in trade, the Association of Southeast Asian Nations is setting up a task force to shift from international currencies, mainly the US dollar. The objective of this task force appears to be to reduce exposure to the US dollar, US banks and the US payment system.
Currency transactions benefit hugely from economies of scale. The more a currency is used – whether to settle exports or imports or to conduct financial transactions such as investments – the lower the transaction costs. This is because more transactions means more liquidity in the system, and foreign exchange traders will have to reduce transaction fees to attract customers.
The bid-offer spread, a measure of the transaction cost in foreign exchange, could be just a few basis points for some of the most frequently transacted currencies, such as the US dollar against the euro or the Japanese yen. However, for some of the less-frequently traded currency pairs, the transaction cost can be substantially higher.
Another benefit of transacting in major currency pairs is the availability of forwards and derivatives. This allows exporters, importers and businesses to hedge against future volatility in the exchange rate.
As a result, authorities in emerging markets need to consider how to boost the volume of foreign exchange transactions on the spot market as well as in forwards and other derivatives to reduce overall transaction costs.
In addition to trade in goods, the US dollar is also the most used currency in financial investment. The fact the largest stock and bond markets in the world are denominated in the US dollar also adds to the depth of its foreign exchange market and further reduces transaction costs.
Dollar weaponisation is creating a more fractured world
With these advantages in mind, it is not surprising that the US dollar is used in around 90 per cent of foreign exchange transactions around the world, according to the Bank for International Settlements (BIS).
This represents progress after a decade of effort. Even so, there are still plenty of financial developments needed in China before the yuan poses a challenge to US dollar dominance.
Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management