Daily Update: August 23, 2024

Advocates for the de-dollarization of international trade view the US dollar's use as a global reserve currency as a kind of financial imperialism. In Society for Worldwide Interbank Financial Telecommunication (Swift) trade finance settlements, 84% of trading is denominated in dollars. The euro is second, accounting for 5.9%, and the renminbi is third at 5.3%. Because the partisans of de-dollarization believe that the US dollar's dominance in trade is a product of US government policy, they believe that a collective “opting out” by other countries could displace the dollar.

But the dollar is far more likely to be displaced by changing commercial relationships and trade partnerships than it is by government pronouncements. International trade uses the dollar because it is useful. If another currency becomes similarly useful, it will become a global reserve currency as well.

The renminbi-based oil trade serves to illustrate this point well. A recent article from S&P Global titled “Saudi-China ties and renminbi-based oil trade” tells the deeper story.

The history of international trade in renminbi illustrates why the dollar has such staying power. The renminbi was launched as a currency for international settlement in 2009, when a pilot plan in Hong Kong was expanded for use by corporations. Between 2012 and 2015, China worked to expand the use of the renminbi internationally by setting up renminbi clearing facilities and signing swap agreements with trading partners. Then in 2015, the currency depreciated sharply against the dollar. This exchange rate volatility exposed trading partners to currency risk — the renminbi they had received as payment were suddenly worth much less. The losses made the relatively stable US dollar look better as a reserve currency by comparison.

Recently, the issue of de-dollarization has resurfaced among the BRICS countries, which comprise Brazil, Russia, India, China, South Africa, Iran, Egypt, Ethiopia and the United Arab Emirates. China might prefer not to have its trade relationships mediated through US currency, both for financial and geopolitical reasons. With China now accounting for 13% of global trade, the time seems right to revisit the renminbi as a global reserve currency.

The volume of oil trade between China and Saudi Arabia makes that bilateral relationship a natural focus for renminbi-based trade. Between 2009 and 2023, China’s imports from the Middle East surged 3.7x to US$217 billion with the oil trade comprising 84% of those imports last year. Increasingly strong ties between Chinese President Xi Jinping and Saudi Crown Prince Mohammed bin Salman have been reinforced by regular meetings and trade agreements.

However, for Saudi oil exporters, simply accepting renminbi instead of US dollars for oil has complications. The Saudi currency is pegged to the US dollar, so any depreciation of renminbi against the dollar would have negative financial consequences. In addition, the Saudi trade surplus with China means that Saudi businesses and banks could end up holding excess renminbi that would need to be exchanged for other currencies before being spent. Foreign exchange of currency in the billions of dollars requires complex financial instruments to hedge against risk, and those financial instruments are still in their infancy for the renminbi.

The solution to this problem for Riyadh and Beijing is something of a win-win scenario. Saudi Arabia’s Vision 2030 involves a series of massive construction projects, such as the new city of Neom. Six of the 10 largest construction contractors by contract value in Saudi Arabia are Chinese companies. This means the Saudis can use their excess renminbi from trade to hire Chinese companies that are happy to be paid in Chinese currency. For China, this expands the international reach of its companies and makes it easier for a major trading partner to accept renminbi-based trade. In this way, de-dollarization happens through mutual advantage.

Today is Friday, August 23, 2024, and here is today’s essential intelligence.