There is no doubt that the US dollar has been the world’s reserve currency for over 100 years. Just now, though, its status appears to have taken a knock. Recent developments on the global markets have raised suggestions that the greenback may have passed its zenith. The Middle Kingdom in particular would like to weaken the dollar's influence on global trade, which is why Beijing has lately put an emphasis on settling oil and gas deals in the yuan. Indeed, the communist government has just marked a further success: its state-owned oil and gas giant CNOOC and the French TotalEnergies completed the first LNG trade in the Chinese currency at the end of March.
Beijing has long been trying to conclude more trade agreements officially in the yuan, or renminbi (RMB), as the currency is generally known in the People's Republic. During a visit to the Saudi capital, Riyadh, in December 2022, president Xi Jinping made it clear that China would use the Shanghai stock exchange “to the full extent” as the platform for yuan settlements of oil and gas deals. This strategy of the Middle Kingdom is being well received in Russia especially, which is increasingly accepting the yuan as a result of Western sanctions. There is still a long way to go before the greenback is booted out completely as the global reserve, however, with some 41% of world trade being transacted in dollars and only around 2.7% in the yuan. Furthermore, about 60% of all foreign exchange reserves are held in the US currency in the form of government bonds, for instance. Here, though, China is coming back into the game: its US government bond holdings amount to some USDtn 1. Should Beijing put these on the market, the greenback would be severely weakened and could possibly lose its dominant position.
On the one hand, then, possible bond sales hang over the dollar like the sword of Damocles. On the other, China is keen to establish its own currency in global trade. The joint study by the Wilson Center and the British market researcher Enodo Economics comes to the conclusion that Beijing will make progress over the next five years, particularly in sectors that had not previously been critical to Beijing’s internationalisation of the RMB. Among the main sectors cited by the experts, for instance, is the increasing inflows of Chinese savings into Hong Kong's financial markets. In addition, Beijing is set to make technical adjustments so that Chinese government bonds can be used as security for cross-border financial transactions, something which could trigger a worldwide surge in demand for these instruments.
Another factor dragging on the greenback is the sometimes huge difference in interest rates between the USA and emerging countries. Both the Mexican and the Brazilian central banks, for instance, had already stepped on the monetary policy brake before the Federal Reserve did so, which in turn led to positive interest rate differentials against the US dollar. The Banco Central do Brasil started its cycle of increases back on 17 March 2021, hiking the base rate from 2.00% then to 13.75% now. To compare, the Fed has lifted its interest rate spread from 0.00% to 0.25% in March 2022 to 4.75% to 5.00% now. The significant widening of interest rate differentials is also driving exchange rates, with the Brazilian real appreciating by about a tenth against the greenback since May 2021.
Source: Central banks, Refinitiv