Chinese leaders want to reduce their economy’s dependence on the dollar and to promote the use of the yuan for global trade and investment in Asia and beyond. Eventually, they want the yuan to become the reserve currency in China’s sphere of geopolitical influence if not the whole world. 

The Party has patiently been laying the groundwork to advance the international use of its currency. Their plan has now begun to take shape. 

In a series of Enodo Weeklies we will examine each piece of the puzzle and then put them all together in a coherent picture in an Enodo Untangled report. We will argue that global financial markets are on the cusp of radical change.

Beijing’s three wake-up calls

Most of China’s trade is denominated in dollars, most of global trade finance is carried out in dollars and trading in commodities is settled in dollars. The Global Financial Crisis (GFC) rang alarm bells in Beijing. Not only were Chinese exporters exposed to currency volatility and conversion costs, but world trade almost came to a standstill because exports could not be financed. Beijing pledged to never be exposed like this ever again. 

The second wake-up call came when Edward Snowden – the former National Security Agency (NSA) contractor – leaked a range of American intelligence secrets in 2012-13. Among the disclosures was that the NSA monitors financial transactions on the SWIFT global network. SWIFT is a crucial payments gatekeeper, providing electronic instructions on how to transfer money among 7,800 financial institutions worldwide. 

Arguably, this was not the first time it had been revealed that the US government monitored SWIFT, which is based in Brussels. In 2006 a New York Times article reported that a US emergency programme initiated after the Sept 11 attacks to track terrorist finance on SWIFT had become a permanent feature. But the Snowden revelations in their entirety were certainly pivotal. 

The Chinese Communist Party, obsessed with control and highly averse to any foreign interference in its domestic affairs, realised that it was reliant on a global payments system that could be tapped by US intelligence agencies and that Washington could use to deny Chinese banks access to dollar funding. 

The US has recognised that, since China entered the World Trade Organisation in 2001, its policy of engagement with Beijing has not worked as expected. Trump’s trade war started a fundamental rethink of America’s China policy which has garnered an unusual bipartisan consensus on the need to be tough. Shutting China out of the dollar-based system would be a financial “nuclear” option for the US, as we have argued on several occasions. Nevertheless, it is a crucial vulnerability which Beijing has sought to address. 

The third wake-up call was the invention of blockchain technology and the success of Chinese entrepreneurs in creating a new domestic mobile payments system leapfrogging the card-based Western model. Chinese businesses have excelled at taking existing innovations and modifying them to provide a range of new customer-facing services that reduce or eliminate many of the frictions inherent in Chinese urban life. 

China is fast becoming a cashless society. WeChat and Alipay now have more than 890m users and account for over 90% of the mobile payments market. 

De-dollarising China’s Asian Trade 

In response to these realisations Beijing embarked on a comprehensive plan to diminish its dependence on the dollar-based global payments system and to internationalise the use of the yuan. Shortly after the GFC in 2009, China began signing bilateral currency swaps with other countries’ central banks. By now its central bank – the PBoC – has such credit lines with over 30 countries. 

China's Swap Lines

Line color and thickness both denote the maximum amount drawn in $ equivalent, billions. Unused swap lines indicated in gray.

Source: CFR

In a global financial system heavily reliant on the US currency, a web of central bank swap lines woven by the Fed serves as a critical, elastic backstop for the private provision of dollar liquidity. While still a work in progress, China is now much closer to having a similar network of swaps centred on the PBoC, able to provide yuan liquidity. 

Since the GFC China has managed to stabilise its exchange rate against other Asian currencies after extraordinary volatility in the 90s and noughties. The spreads between those currencies now resemble those between European currencies in the Exchange Rate Mechanism, which was designed to reduce exchange rate variability before member countries adopted the euro. The first goal is for China to move Asian trade away from being denominated and settled in dollars. 

In 2009 the State Council – China’s cabinet – launched a pilot scheme for trade settlement in renminbi and expanded it to the whole of the country in 2011. Despite its efforts, initial success in expanding the use of the yuan in global trade has faltered. The share of Chinese trade denominated in renminbi has now more than halved from its 2015 peak. 

The authorities have realised that for this endeavour to work, China must open its domestic capital markets to foreign investment. We’ll discuss the next phase of renminbi internationalisation in another Insight. For now, let’s keep looking at the financial plumbing China needs to install to guarantee its security in the current system and to be able to supplant the dollar. 

Addressing the SWIFT problem

In 2009 China started work on its own cross-border renminbi payments network, the China International Payments System (CIPS), which it launched in 2015. CIPS provides the infrastructure to connect global RMB users through a single system. It is modelled on the Clearing House International Payment System (CHIPS), the US dollar payments network. CIPS is still using SWIFT for interbank messaging but the plan is for it eventually to be able to operate independently.

In 2019 SWIFT announced it was setting up a wholly-owned subsidiary in Beijing to offer localised services in China and accept the yuan as a settlement currency. Earlier this year SWIFT established a joint venture with four institutions that come under the PBoC, including CIPS and, interestingly, the central bank’s digital currency research institute. 

China realises it is unreasonable to supplant SWIFT at this stage, given its enormous positive network effects. Rather, Beijing’s aim is to do all it can to safeguard China’s economy and international payments data as long as it remains dependent on the dollar-based global payments system. Crucially, the joint venture with SWIFT serves this very purpose. 

According to the PBoC, the link-up is designed to “enhance the stability, resilience and security of transmission” and “for cross-border financial information to be stored in China for the purposes of risk control and supervision”. To be blunt, China is keen to store its international payments data locally out of the reach of the CIA. It is highly likely that the joint venture with SWIFT will be doing just that. 

Conclusion

For China, reducing its dependence on the dollar is critical but the substantial progress it has made in building the financial infrastructure it needs to do so has largely gone by unnoticed. If the Party succeeds in establishing the renminbi as a rival reserve currency, the geopolitical, economic and market consequences would be momentous. That’s something we’ll explore in depth at the end of this series.