China’s Alan Greenspan says the fate of the US dollar lies in the hands of Beijing
Zhou Xiaochuan expects US dollar to retain global dominance unless the renminbi fights for it.
Zhou Xiaochuan (周小川) - the storied former governor of the Chinese central bank, has offered his sage opinion on the impact of the Sino-US trade war on the global monetary system and US dollar dominance.
In a recent opinion piece, Zhou examined the prospects for the renminbi to supplant the US dollar, in light of Trump’s tariff war “[creating] opportunities for the renminbi to play a greater role.”
While some may argue that the renminbi could be poised to supplant the dollar, Zhou highlights barriers to its ascent, including lack of a large and accessible market of stable financial assets and capital account convertibility.
Consequently, Zhou sees the US dollar likely retaining its dominant position, until Beijing amasses the political will for the financial reforms needed to drive international usage of the Chinese currency.
The trade war is a monetary issue
Zhou - who headed the Chinese central bank during the Global Financial Crisis (GFC), argues that exchange rates and monetary policy lie at the very heart of the heated trade war raging between Beijing and Washington.
“It’s normally held that trade and tariff conflicts should be analysed from the perspective of just trade,” Zhou wrote in an opinion piece published on 11 October (“周小川：美元的两难选择与国际货币体系的变革机遇”).
“I however, believe that this is not enough - many scholars argue that the current dispute actually involves monetary [policy] in the background, which of course also involves the international monetary system.
“When observing trade and tariff disputes, we cannot avoid discussion of monetary matters.”
The US can wage the trade war by undermining the dollar
An oft-cited means of curing trade imbalances lies in the use of monetary policy by central banks to reduce the value of a nation’s currency, thus heightening the appeal of its exports.
Zhou believes that the Trump administration is prepared to resort to such measures as a means of favourably shifting the US balance of trade.
“Several senior officials within the Trump administration have already discussed the use of monetary methods to strengthen US manufacturing and export competitiveness,” he writes.
“Simply put, this involves maintaining an even lower US dollar exchange rate…it’s for this reason that monetary policy cannot be avoided when discussing tariff and trade wars.”
Zhou argues that dollar depreciation creates the quandary of a policy trade off for Washington, forcing it to choose between a reduction in its trade deficit and the preservation of US dollar dominance.
While reducing the dollar exchange rate could help shore up US exports, it would also compromise the dominance of the US dollar, and all the benefits that accrue to Washington as a result.
These include the “exorbitant privilege” of seigniorage, the ability to apply sanctions to nation-state adversaries, as well as access to low cost credit from an international market hungry for US treasuries.
Despite the challenges involved, Zhou believes it feasible for Washington to both reduce the exchange rate to bolster American exports, while at the same time preserving the dominant position of the US dollar.
The prerequisite for achieving this difficult feat, however, will be the absence of a rival currency to challenge the dollar’s hegemonic status.
“It’s not at all entirely impossible for the US dollar to do both,” Zhou writes.
“Even if the US dollar is trending towards weakness, its remit is shrinking, and it’s flippantly used for sanctions, as long as there is no other currency which emerges to challenge it, then [the dollar] can achieve all its objectives.”
This being the case, then whether or not Beijing is willing and able to internationalise the Chinese renminbi could be the deciding factor in the US dollar’s continued dominance.
Can China successfully internationalise the renminbi?
Zhou maintains the equivocacy characteristic of the central banker when it comes to the matter of whether the Chinese renminbi is currently positioned to replace the US dollar as reserve currency.
He firstly argues against the widely touted notion that China needs to run a US-style trade deficit in order to export its own currency for overseas usage, pointing to the option of instead using outbound loans and investment, as well as central bank currency swaps.
Zhou highlights, however, China’s comparatively small market for financial assets, in combination with Beijing’s anxieties over capital flight, as enduring barriers to greater internationalisation of the renminbi.
Huge trade deficit the key to US dollar dominance
The huge trade deficit that the US has run up vis-a-vis China and other nations lies at the core of the Trump administration’s renewed tariff war, and the protectionist mindset that threatens to undermine the greenback.
Zhou points out, however, that this very trade deficit may have contributed to the entrenched dominance of the US dollar, making it difficult for other options (such as the euro, the Chinese renminbi or special drawing rights) to replace it.
This is because a trade deficit expedite the export of a nation’s currency abroad, creating an huge overseas supply for use as global money.
“Some analysis contends that if a nation wants to export its money, it must run a large trade deficit, which means that imports are far larger than exports,” Zhou writes.
“Only then is it possible to export large sums of money for other people to use.”
Does China need to run a deficit to internationalise the renminbi?
This same vein of analysis argues that the renminbi cannot replace the US dollar as global currency, because its trade surplus means that any currency that heads abroad rapidly remigrates back home, as foreign buyers purchase goods made in China.
“With China’s large trade surplus, even if the renminbi is used for settlement and exported, when another nation buys Chinese goods, the renminbi returns,” Zhou writes.
“For this reason, there will not be a large volume of renminbi reserves outside of the country.”
This line of reasoning further asserts that the only way for China to achieve full internationalisation of the renminbi would be to start running its own trade deficit, potentially following the lead of the US in hollowing out domestic industry.
“If we were to do the same as the US, and used large trade deficits to export money, then this would cause harm to our own economy, manufacturing sector and employment,” Zhou warn.
“This is currently the situation that the US is reflecting upon and attempting to change.”
How China can safely export the renminbi
Zhou disagrees with the conclusion of the aforementioned line of reasoning. He argues that China does not need to run a huge trade deficit - and risk destroying domestic industry and employment, in order to export sufficient volumes of the renminbi to make it fit for widespread international usage.
This is because China can resort to multiple financial channels to channel the renminbi externally, instead of just buying commercial goods produced by other countries.
“It is not necessarily the case that trade surplus nations lack channels for exporting their own currencies so that other nations can use them,” Zhou writes.
“China can use the financial account to export large volumes of the renminbi externally…this would involve the use of investments, lending and financial market transactions.”
Proof of this lies in the fact China had high savings rates that led to the export of large sums of capital in the years leading up to the 2008 Global Financial Crisis.
Zhou notes that Ben Bernanke - chairman of the US Fed during the GFC, imputed America’s sub-prime crisis to China’s high savings rates.
“[Bernanke] believed that Asia, including China, had excessively high domestic rates, and a large volume of these savings entered the US market via the dollar, putting pressure on domestic interest rates and household saving rates in the US.”
Zhou further notes China also has the option of exporting the renminbi via central bank currency swaps, which Beijing has already entered with multiple emerging economies.
While the swaps are theoretically bi-directional, Zhou argues that they usually only flow in one direction.
“This is determined by who needs forex liquidity, as well as who has the ability to export [currency],” he writes.
“Usually, it is the nation whose saving rates are higher than its investment rates that inevitably becomes the reserve exporting country - such as China.”
The real barriers to renminbi internationalisation
While Zhou argues that it’s possible for China to both run a trade surplus and export its currency abroad, he points to other potential pitfalls on the renminbi’s path to widespread international adoption.
The first is the absence of a large and accessible market of secure assets denominated in the renminbi - a feature considered indispensable for an international reserve currency, even if a huge trade deficit proves unnecessary.
“Some lines of analysis argue that in order to fulfil the reserve currency function, [a nation] needs to be able to provide stable, and secure assets,” Zhou writes.
“Looking at matters globally, US treasuries still appear to be the most stable and secure asset in the world.”
Zhou notes that the renminbi can now be readily accepted as a medium of exchange for payments internationally, given China’s vast output as the world’s leading manufacturing nations.
“The renminbi possesses strong purchasing capability, because China is a great manufacturing power,” he writes.
“Even if China cannot produce a certain product, it’s still possible to use the re-export trading capability of trading companies to obtain it.”
However, when it comes to using the renminbi to create stores of value - by purchasing financial assets denominated in the currency, China continues to fall short.
“Overseas purchasers often simply purchase the renminbi when they’re about to make buy [products]…they do not hold the renminbi in their own hands for long periods of time,” Zhou notes.
“This clearly indicates that when it comes to stable and secure assets, the renminbi is perhaps still lacking, and this is influencing the decisions of currency holders.”
Zhou also highlights the vast gulf between China and the US when it comes to accessible financial markets - a gulf which could prove an insuperable barrier to the renminbi - or any other contenders - replacing the greenback.
“In 2007, before the outbreak of the Global Financial Crisis, the total amount of overseas US dollar assets was US$1.2 trillion,” Zhou writes.
“By 2024, this figure soared to US$26.2 trillion. The increase during this period is staggering.
“Consequently, if a currency wants to serve as a reserve currency, it is necessary to clearly ascertain whether it can replace more than US$20 trillion (in assets), or to truly bear the original amount required for the role.”
Beijing still frets over capital outflows
Even if China were to oversee the creation of a large market of accessible financial assets to support international usage of the renminbi, Zhou points out that Beijing would still need to overcome its entrenched reluctance to open up the nation’s capital account.
He notes that capital account convertibility is another prerequisite to renminbi internationalisation - one closely tied to the aforementioned need for access to a large volume of stable financial assets.
“[Renminbi internationalisation] requires greater progress in reform and opening up - in particular currency reform, including further promotion of capital account convertibility.
“According to the IMF, this means increasing the free usage of the renminbi and reducing needless regulations.”
Zhou points out, however, that one of the main barriers to Beijing “playing the renminbi card” lies in “concern over capital outflows,” and the threat they pose to China’s financial system.
“Historically, our capital outflows have often been periodic in nature - sometimes they have been quite severe.”
For this reason in particular, Zhou advocates for China’s economics community to engage in greater analysis and discussion of renminbi internationalisation, to devise better arguments for wielding the renminbi as a “card” in Beijing’s strategic rivalry with Washington.
“For China, the renminbi is becoming a card in an international game,” Zhou writes.
“This is to say that the US is playing the tariffs card, begging the question of what card China should play. There are many options, one of which is the renminbi.
“In the current global game, whether or not we can summon the determination to make the renminbi play a greater role, will to a very large extent be determined by our analytical framework.”