Seventy-five years after the Bretton Woods agreement was signed, making the US dollar the world’s reserve currency, there is talk of an alternative. The US’ weaponising of its currency may well accelerate the process.

SINGAPORE (July 15): For more than seven decades, the US has been arguably the world’s most powerful nation, its influence stretching far because of the mighty dollar, which is in turn supported by the strength of its economy. Its bond and equity markets are the largest and deepest; global trade is settled in US dollars and valuable commodities such as oil and gold are priced in US dollars.

Under the current Trump administration, however, the US is no longer seen as a benign superpower. The administration has been accused of weaponising the US dollar to sanction and exclude, from the US trade settlement system, countries and companies it does not agree with. European companies doing business with Iran have been hit. And now, the Shanghai Pudong Development Bank runs the risk of being shut out of the US dollar market for doing business with North Korea.

Despite these displays of power, some experts believe the reach of the US — and its currency — is waning. And, this has led to talk of the renminbi, in addition to the euro, overtaking the dollar as the global reserve currency.

“The economic strength of the West is weakening,” notes James Wolfensohn. “China and India [will] demand a leading position in the organisation of the international community.” Wolfensohn is a former president of the World Bank and current co-chair of the Bretton Woods committee. “China has already applied its global influence to bring together most of the nations of the world to be shareholders in a new global investment bank — the Asian Infrastructure Investment Bank (AIIB) — an institution that can do much of the work currently done at the World Bank,” he adds. Wolfensohn’s comments were included in a report launched on July 4 in commemoration of the 75th anniversary of the Bretton Woods system.

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Indeed, the Bretton Woods treaty signed in 1944 by 44 countries — including the US, the UK, Australia, China and the then-USSR — was the genesis of the rise of the power of the US and the greenback. Under the agreement, the signatories agreed to peg their currency to the US dollar, which was in turn pegged to the price of gold, fixed at US$35 an ounce. The agreement also stipulated the standardisation of international trading norms, based on free-flowing trade. The countries settled their balance of international payments in US dollars, which were fully convertible to gold. As a result, the US dollar became the world’s reserve currency.

That system created a strong demand for the US dollar — especially as the Cold War between the US and Soviet Union intensified and West Germany and Japan experienced exponential growth. The US was responsible for keeping the price of gold fixed and the supply of dollars flowing. Meanwhile, other countries converted their US dollars into gold and took the precious metal offshore.

In 1971, US President Richard Nixon went on to unilaterally abandon the convertibility of the US dollar to gold. The so-called “Nixon shock” effectively brought the Bretton Woods system to an end, and roiled economies globally. But it also cemented the dollar’s position as the global reserve currency and made the US a financial hegemon, acting as both a lender and consumer of last resort.

However, market watchers have now observed the rise of China’s economy and its influence. Data from the World Trade Organization (WTO) shows that the GDP of the world’s second-largest economy was US$12.1 trillion in 2017, of which 19.1% was from trade. In comparison, the US’ GDP in 2017 amounted to nearly US$19.4 trillion.

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That year, China was the top global exporter of merchandise, as well as the world’s fifth-largest exporter of commercial services. Despite its trading heft, however, the renminbi is not as widely used as the US dollar or the euro for global trade. This is because China’s current account is not fully convertible.

However, in a research paper discussed at the recent Asian Monetary Policy Forum hosted by the Monetary Authority of Singapore, French economist Pierre-Olivier Gourinchas notes that the dollar hegemony is not sustainable, despite its stability. “The global economy will have to transition, at some point in the future, either to another single anchor, or to a multipolar environment,” he says, with candidates for the alternative currency being the renminbi and possibly the euro, as a weaker contender.

The implication of being the global reserve currency, in the words of Kay Van-Petersen, global macro strategist at Saxo Capital, “is that the world dances to your beat”.

“When we have a financial crisis that originates from the US, because of the hegemonic position of the US dollar, it is able to export some of its problems to other countries,” says Li Mingjiang, associate professor at the Institute of Defence and Strategic Studies at the S Rajaratnam School of International Studies (RSIS).

Most notably, what started out as defaults in the US subprime mortgage market developed into a full-blown global credit crunch. Developing markets could not stomach the reduced foreign investment, trade and remittances and faced growing trade deficits, currency devaluations, increased debt and higher rates of inflation. By end-2010, such economies had lost an estimated US$2.6 trillion in output, a report by the UK’s Institute for Public Policy Research notes.

And it was a flood of US dollars that helped resuscitate the ailing global economy. Ben Bernanke, then chairman of the US Federal Reserve, adopted quantitative easing to provide the markets with much-needed liquidity, as well as drive demand for assets.

Even so, says Van-Petersen: “We’re always looking for this displacement of the global reserve currency.”

China’s internationalisation

Over the past decade, China has taken numerous steps to open up its capital account and internationalise the renminbi. It has signed bilateral currency swap agreements with about 30 countries and, in 2010, it introduced its offshore renminbi (CNH) for trade in goods and services settled outside the country in the renminbi settlement centres of Hong Kong, Singapore and London. CNH operates without restriction, and demand is driven by expectations of an appreciation of the currency. That has in turn made the borrowing costs of the CNH bond market much cheaper than those on the mainland.

In 2014, China went on to launch the Stock Connect scheme — a collaboration among the Hong Kong, Shanghai and Shenzhen stock exchanges — to allow investors to trade securities in all three markets through the trading and clearing facilities of their home exchange. Investors can trade over 2,000 equities across the three exchanges, enabling funds to flow more freely.

To reach out to the corporate sector, China launched the Cross-Border Interbank Payment System (CIPS) in 2015, which provides the infrastructure needed for further internationalisation of the renminbi. This system offers clearing and settlement services in cross-border renminbi payments and trade.

“Through these channels, investors and corporations can use the renminbi to invest in domestic assets,” says Wong Yii Hui, senior portfolio manager at Nikko Asset Management.

These measures paved the way for bigger wins for China. In October 2016, the International Monetary Fund (IMF) included the renminbi in the Special Drawing Rights (SDR) basket of currencies, alongside the US dollar, British pound, euro and Japanese yen (see table). This indicates the free use of the renminbi internationally.

In 2017, the renminbi was included in the reserves of global central banks. Figures from IMF show that claims in renminbi made up nearly 2% of total allocated reserves globally as at end-March 2019 (see Chart 1). In absolute terms, the amount of renminbi in reserves has increased 46% from US$145.7 billion in 1Q2018 to US$212.9 billion in 1Q2019.

Reports from SWIFT, a financial transactions network, show that the renminbi has inched up one spot between May 2017 and May 2019 — following its macro gains — to become the fifth-most-used currency for international payments, accounting for 1.95% of international payments. It is surpassed by the US dollar, euro, pound and yen (see Chart 2).

And, there has also been the emergence of the petroyuan — the pricing of oil futures in yuan, or renminbi. This follows the launch of a new oil futures contract on the Shanghai International Energy Exchange on March 26, 2018. With China being the world’s largest oil importer, its capacity to insist on oil purchases being denominated in renminbi has grown. Already, China-Russia oil contracts are denominated in renminbi, and Iran, Iraq, Venezuela and Indonesia follow this practice to varying degrees. This is a huge step in enhancing the usability of the renminbi.

To be sure, the use of the renminbi was not always this seamless. The Chinese economy has been known to be closed and difficult to manoeuvre. In 2008, in the wake of the global financial crisis (GFC), the Bank of China struggled with a severe shortage of US dollars, owing to the tight grip the government had imposed on the foreign exchange market. Contributing to the shortage were restrictions on the onshore supply of dollars aimed at limiting the inflows of speculative money betting on the renminbi. In addition, quotas imposed on foreign currency holdings by the State Administration of Foreign Exchange (SAFE) in 2007 started to backfire — foreign banks were made to cut holdings to 60% of 2006 levels while domestic banks were made to cut holdings to 30%. Meanwhile, the Chinese central bank had some US$1.65 trillion in reserves, which proved insufficient when the commercial banks were unable to renew the supply of the US dollar, following the adoption of these stringent requirements.

Nikko’s Wong notes that this was a turning point for the Chinese government, as the possibility of a foreign currency debt problem prompted it to internationalise its currency and open up its economy. “I think the GFC made [the Chinese government] realise that the export-led growth model, which had done well since China’s entry into WTO, was no longer sustainable. To alleviate the issue of shortage of dollar liquidity again, their idea of internationalising the renminbi gained momentum,” she says.

But Wong stresses that internationalising a currency is an arduous process. The development of the domestic market has to be balanced with how much liberalisation can be allowed. The process should start with the huge state-owned enterprises. Not only do they contribute substantially to China’s economy, but many are also active international traders of goods and services.

“When you have a strong domestic market, people will start to have confidence in your currency, in your policies, and they will start to use your currency. This comes hand in hand with opening up your borders, which ensures the capital account’s convertibility,” notes Wong.

BRI: China’s USD-funded plan

President Xi Jinping’s efforts to open up the Chinese economy should have made the renminbi more readily available, and therefore easier to use in global trade and investments. China’s internationalisation projects, notably the expansive US$575 billion ($779.3 billion) Belt and Road Initiative (BRI), stretching across 71 countries in Asia and Africa, should also drive demand for the renminbi.

A recent SWIFT report shows that in May, of China’s top 15 trade partners, Hong Kong, the UK and Singapore had the highest volumes of offshore trade with China, accounting for 75.3%, 6.1% and 3.4% respectively. About 75% of offshore renminbi payments for trade with China were made by Hong Kong, while the remaining 25% came from other countries.

“Payments, traffic as a whole have increased between these countries and China,” Wong says. However, it seems that more needs to be done. “In the Asean region, it still takes time because you need back-end infrastructure to be set up first, which is currently happening.”

The renminbi has yet to become the internationally recognised unit or widely used currency of exchange that a global reserve currency needs to be. In fact, even China’s BRI is not funded in renminbi, even if it may seem obvious that it should be so. Moreover, SWIFT reports that 61.8% of the world’s allocated reserves are still in US dollars.

In fact, the US is heavily indebted to China, the largest holder of its Treasury bonds (see Chart 3) with some US$1 trillion in holdings. The US currently also has a goods trade deficit of US$30.2 billion with China, after Beijing retaliated to US President Donald Trump’s import tariffs. Overall, the US is running a trade deficit of US$55.5 billion (see Chart 4).

But despite its size and status as a creditor nation, China’s currency has a very small share of the global payments system. Jonathan Cavenagh, executive director and head of emerging Asia FX strategy at JP Morgan, says: “The share of global FX reserves in renminbi to global payments or use in transactions is very low compared with China’s share of GDP in the world and its share of trade in the world as well. China has for a long period of time maintained a fairly closed capital account. Now, slowly, that is changing, but I would stress, very slowly.”

While RSIS’ Li is more optimistic about the possibility of the renminbi’s becoming an international currency, he has his reservations because of the Chinese government’s iron-fisted approach in managing and intervening in its economy. “I don’t see any possibility of the Chinese government adopting a laissez-faire financial policy to allow these financial movements [to be] dramatically much freer in the near future. If China does that, it will mean that the government will lose a lot of control over the overall Chinese economy and economic and financial activities between China and the outside world.”

According to Li, over the years, the wealthy in China have transferred their wealth and financial resources overseas. “Even today, there is still pretty strong interest among the wealthy in doing this. Simply because of this factor alone, the Chinese government cannot allow the free cross-border flow of financial assets,” he adds.

Meanwhile, the liberalisation of ­China’s financial sector will take “quite a bit of time”, notes Li. “The Chinese government is quite concerned about the backlash or negative consequences if reforms in the financial sector move too fast.”

For now, while the greenback continues to account for nearly all of global trade settlement, there is talk about nations in Europe and Asia looking for an alternative. The renminbi may not replace the US dollar as the global reserve currency in the near or even medium term, but it is beginning to make a dent in the greenback’s hegemony. And if the US’ allies and adversaries alike continue to be antagonised, they may well start looking elsewhere for a replacement to the greenback. — With additional reporting by Thiveyen Kathirrasan

Gold revival

There has been a recent spike in the purchase of gold globally, spurred by massive buying from central banks. Recent data from the World Gold Council (WGC) shows that central banks’ net purchases of gold totalled 145.5 tonnes in 1Q2019. This was 68% more than the year before, and the strongest 1Q purchase since 2013, when 179.1 tonnes were bought.

Among the central banks, Russia led the charge, scooping up 55.4 tonnes in 1Q2019, while slashing its US Treasury holdings. China was another large buyer, with a purchase of 33 tonnes. This is significant, as Beijing resumed gold purchases only last December after a 25-month pause.

Major buyers of gold include countries such as Turkey and India, which are also taking steps to switch out of US dollars in their bilateral trade deals. China, too, is moving towards internationalising its currency by encouraging its Asian trading partners to use the renminbi.

Overall, as at July, the US was the country that held the most gold, with 8,133 tonnes, accounting for 74.5% of its reserves. Germany was a far second, with 3,368 tonnes, followed by the International Monetary Fund with 2,814 tonnes. China came in at No 7 with 1,916 tonnes, which made up 2.5% of its total reserves. It is behind Italy, France and Russia, which were in fourth, fifth and sixth positions respectively. The Monetary Authority of Singapore was ranked 29th, with holdings of 127.4 tonnes, making up 1.4% of its total reserves.

Retail investors too have been riding this trend, buying 86%, or 907.8 tonnes, of the 1,053.3 tonnes purchased in 1Q2019.

Despite heightened demand for the precious metal, which is still widely seen as a safe-haven and liquid asset, market watchers do not expect a return to the gold standard.

Shaokai Fan, director of central banks and public policy at WGC, acknowledges that gold “fulfils many necessary objectives for central bank reserve management”.

But he adds: The classical gold standard is not well suited to the modern world economy, which has grown significantly larger and more diverse since the gold standard era. Gold will nevertheless continue to play a leading role in central bank reserve portfolios and an integral part of the international monetary system,” he tells The Edge Singapore. — By Amala Balakrishner