Rise of the Chinese Yuan
– Puru Shrestha
Background
After the disastrous policies of Mao Zedong, namely the “Culture Revolution” and the “Great Leap Forward” it is estimated that over 50 million people died in China which caused a severe hardship and economic downturn.
After Mao, Deng Xiaoping became the paramount leader, who liberalized the Chinese economy by loosening the grip of its central government. His famous saying was, “不管黑猫白猫，捉到老鼠就是好 猫。 Buguan hei mao bai mao, zhuo dao laoshu jiu shi hao mao. No matter if it is a white cat or a black cat; as long as it can catch mice, it is a good cat.” So, he promoted the idea of letting some people get rich first, then replicate that success to everyone else in China. To accomplish this, he created a “Special Economy Zone” called Shenzhen, which was a coastal city near Hong Kong that has a similar financial structure of a free market economy. This openness brought foreign investment and technology in China, which they needed desperately. It was extremely successful and became the launch pad for the rest of the country.
Many other cities, Guangzhou, Hangzhou, and Chengdu started replicating this model. Foreign companies from all over the world went in to take advantage of cheap labor and a stable political environment. Thus, China became the “World’s Factory”, which, in turn, made China the fastest growing economy in the world, for decades. For comparison, in 2022, China’s total export was $ 3.594 trillion, whereas India’s total GDP for the same period was $ 3.469 trillion.
Obviously, when a country exports more than imports, it will have a trade surplus. In 2022, China had a trade surplus of approximately $877.7 billion, despite also being the largest importer. In 2022, China’s total export was $3.594 trillion, whereas import was $2.716 trillion. So, being the biggest importer and the exporter, it is bound to have plenty of influence over its trading partners.
Current Position of Yuan by Region
Russia:
The primary source of income for the Russian Federation (RF) is the export of energy, and precious metals, namely gold. Due to the sanction imposed by the Western countries after the Ukraine invasion, access to the Western market for its export; and to the financial institution to complete the transactions was frozen, which forces Russia to sell its export to those friendly nations, like China, India, Iran, Pakistan, etc. Since China is its largest trading partner, for both export and import, and there is a lack of other currencies like the US dollar or Euro, the RF has to agree to settle its trade in Yuan, which was between $165-$170 billion in 2022.
Historically, due to their similar political ideology, Russia and China were in alignment, where Russia was the primary provider of technological and financial support for China. For example, during the Korean War, and the Vietnam War with the West, Russia provided both military and financial aid to the North Koreans and Viet Cong through China which boosted China’s technical and financial sectors substantially. However, in recent years, when the Russians were losing their dominance, China has been gaining momentum. Coupled with the sanctions imposed by the West, Russia’s position has even further deteriorated, which provided ample opportunity for China to become the alpha player in this bilateral relationship. Thus, even though Russia would prefer to settle its Chinese trade in the US dollar; so, it could use that currency to trade with other countries to buy things it needed for the war efforts, like parts and chips for its plans, tanks, etc., it could not do that because China would not allow any other currency other than its Yuan for such settlements. Despite all this, the trade between these two countries still accounts for less than 5.0 % of China’s total export.
Middle East
Since China imports most of its energy from the Middle East (ME) but can’t export its cheap merchandise to them because they prefer more luxury brands from the West, it suffers a huge trade deficit with these countries. To counter this imbalance, China is proposing settle its account in Yuan. So, the surplus Yuan can be used by these countries to pay for the infrastructure and development projects made by Chinese companies. China is also using its economic influence to create a “soft power” in those countries by investing in their development projects. One such program is called, Belt and Road Initiatives. In 2022, China signed $400 billion trade and investment deals with the countries in this region. Some countries, like Iran, and the UAE have agreed to do some settlement in Yuan, but many of the countries have not decided.
Major Asian Nations
China has a total trade of 1.04 trillion with the other three major economies of Asia, South Korea, Japan, and Taiwan, $362.2, $357.4, and $319.7, respectively in 2022. However, none of these countries are interested in settling in Yuan.
ASEAN
As a block, ASEAN – Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam – is the largest trading partner for China with total trade of $975.3 billion in 2022. None of these countries trade in Yuan.
Western Countries
The USA is China’s biggest single trading partner in both import and export with a total trade of $759.4 billion in 2022. The European Union is the biggest trading partner block for China with total trade of $847.3 billion.
The World’s Creditor
China is currently the largest single creditor in the world, with outstanding loans to other countries in excess of 6% of the global GDP. A recent study published by the Harvard Business Review found that among the 50 developing countries with the highest levels of debt, about 15% of total obligations were owed to China. One recent case is Sri Lanka which defaulted on the loan and has not been able to pay its debt to China even after handing over many assets, like Hambantota International Port for 99 years.
Yuan Dominance Issue
Despite being the world’s largest exporter and importer, and the largest single-state foreign lender, one may ask, why is Yuan not the dominant currency?
Here are some reasons:
1. Lack of transparency in the control of Chinese currency management due to its authoritarian governance system. Since China heavily relies on exports for the continuum of its domestic economy, it has historically always manipulated its currency to keep its exports cheaper than competitors, sometimes even with massive subsidies. So, the lack of transparency and economic policies of China have spooked other countries to adopt Yuan as a reserve currency against the dollar. As stated by Dr. Zaidi Sattar, Chairman of Policy Research Institute (PRI), “When it comes
To the (Russian) Ruble or the Renminbi (yuan), you cannot rely on the transparency of (Vladimir) Putin or Xi Jinping. Since the decision-making process in these countries is rather undemocratic, it is difficult for traders to rely on these currencies as reliable alternatives.” According to the IMF (International Monetary Fund), Yuan only accounted for 2.70% of the world’s reserve currency, which is a prerequisite to be accepted as the world’s trading currency.
2. Counter-steps were taken by the US-led countries to curb Chinese influence via economic and technological sanctions under the national security provisions. For example, in recent years, the USA, Japan, Netherlands, UK, and other European countries have agreed to ban the export of advanced technology to China and restrict the import of goods from China that have some security risk. For example, Australia, the USA, and other countries have banned products, like surveillance cameras, cranes, and other electronic devices from many Chinese high-tech companies, like Huawei. Due to these restrictions, many Chinese companies are already in a dire situation causing a massive closure of their factories. Additionally, due to the theft of intellectual property and unfair competitive advantages given by Chinese authorities to Chinese companies over foreign companies, many have left China either involuntarily or voluntarily. For example, many Taiwanese, South Korean, and Japanese companies have permanently closed their facilities in China or relocated to other countries in the region, i.e., India, Vietnam, Thailand, etc. Case in point, Mazda does not make any automobiles in China, because after stealing Mazda technology, the Chinese automaker simply pushed it out. Even big names like the American Ford Company are having difficulty surviving in China because of the heavy subsidies provided by China’s local authority in its local brand to keep the factory running in its province. Taiwanese Company Foxconn, which makes Apple products has already established an assembly factory in India, which is going to be one of the biggest Apple production facilities.
3. True Economic Condition of China: Due to the Covid lockdown, the global supply chain has severely affected production, distribution, and consumption. As a result, many countries have taken an alternate route to protect themselves from such situations. One such policy is called China Plus One, where companies are finding other locations for their logistics. The most immediate beneficiaries are Vietnam and India. Some countries like the USA are deciding to bring production facilities, especially advanced technologies, closer to home. Intel, TSMC, NVIDIA, and many more advanced chip makers are establishing or moving their production facilities from China to the USA or Mexico. Currently, China has the highest unemployment rate amongst the younger generation, over 17%, and there will be an additional 20 million college graduates this summer.
4. Over-Leveraged Economy: Although China is the world’s largest lender, it is also the world’s largest debtor on the domestic front. Its central and local governments’ loans are over 250 percent of its total GDP. All its high-speed rail systems, massive real estate markets, highways, and cities are built with borrowed money via various investment funds, bonds, and other interagency financial arrangements. The world’s biggest real estate developer Evergrande has defaulted not only on its debt payment, but also on the interest payments of those debts, specifically in the interest of its bonds that were issued in the US financial market. This has created a Shockwave amongst foreign investors. One may ask, why the Chinese government decided to grow its economy based on such a highly leveraged financial mechanism. The primary reason is to increase the country’s total GDP and keep the people employed. Plus, cities and municipalities were competing to outgrow each other to receive funding and promotion
Opportunities from the central government. So, now it has a huge debt with assets that are not performing and are in a huge surplus. For example, none of China’s high-speed rail systems are generating enough revenue to even pay for its operating expenses, let alone pay the debt because the system does not have the needed number of riders that can afford to pay for the ticket which costs 3 times more than the regular train ride. It has over 600 million units of new real estate properties, which are highly leveraged and beyond ordinary peoples’ affordability. If one does the math, the total population of China is 1,400 million. That means every two people can have one unit. These 600 units are not single houses, they are buildings with multiple floors. There are many “ghost cities” in China that are built mainly for investment, but people can’t afford to live there.
5. Population Dividend: As it was stated in the beginning, when China opened its gate to outsiders, the primary reason for its miracle growth was its young population who provided a cheap and reliable workforce for foreign companies. However, after decades of the “one child” policy, its overall population demography has changed drastically. For example, in the coming years, it will not have enough young people to replace its aging population who will be retiring in greater numbers. During the “one-child” policy period, many families preferred boys vs. girls due to social and cultural reasons. So, now it does not have enough females for its male population which is going to exacerbate the population problem even further.
6. Economy Dependence: The entire economy of China depends on imports and exports because it does not have what it needs, and its domestic market is not big enough to consume what it produces. For example, to run its economy, it needs to import both energy and food. Despite being the second largest country in the world, it does not have many natural resources, i.e., more than half of its land are either desert or mountains, thus not arable. It imports almost all raw materials from as far as South America and Africa. Foods from the USA. Although it still has the world’s second-largest population, after India, the Per Capita to GDP ranking is 65th and Purchasing Power to GDP is 75th. As per a recent speech from outgoing Chinese Premier, Li Keqiang, the majority of Chinese earn less than a dollar a day. Despite the economic boom, the average population does not have enough purchasing power to consume what it produces. Thus, it needs the world to survive. However, even after Covid, the world’s consumption rate has not come back to the normal level, causing a decline in imports from China, which, in turn, decline the manufacturing jobs.
7. Neighbors: Another secondary factor is the geographical border that China shares with its fourteen other nations, with whom, mostly has an adversary relationship that warrants a massive expenditure in its defense, which, in turn, impacts its resource allocation.
Conclusion:
China has been growing in the past three decades, mainly due to the globalization of the world economy, where the world enjoyed peace dividends by cooperating in the production, distribution, and consumption of goods and services from one part of the world to another via a free trade through the process of maximizing each other’s strengths. China played the role of being a low-cost reliable producer. The world poured its know-how and capital into China. China gained knowledge and a financial surplus. It started exerting its economic and technological influences over developing and developed countries. But since it has over-stretched itself in both the domestic front (by over-leveraging its finance) and international front (by acting out as a wolf warrior), it has cornered itself. For example, China has now more aligned itself with authoritarian countries in the world than democratic countries. Case in point, China’s close alias now are Russia, Saudi Arabia, Iran, Pakistan, Belarus, etc.
To counter China’s influence, specifically in the Indo-Pacific region, more countries are aligned with each other. For example, Japan, South Korea, Philippines, Vietnam, India, Australia, Taiwan, etc. have increased their defense budget and have created many multilateral security groups, like AUKUS (Australia, the United Kingdom, and the United States), and QUAD (Quadrilateral Security Dialogue). The Philippines have opened its multiple ports in the USA to operate and conduct joint exercises.
For a country’s currency to be the world reserve currency, it has to have to pass some of the basic parameters, such as liquidity risk, credit risk, and reputation risk. From what has been observed so far, Yuan may be successful in replacing the dollar in some markets with whom China has a friendlier relationship, but not so much in the world arena.
