US coronavirus stimulus reignites China’s criticism of dollar hegemony, but no alternative seen any time soon

The US economic policy response to the coronavirus crisis and the threat of financial sanctions on China have reinvigorated criticism in Beijing over US dollar hegemony, but few analysts see a viable alternative currency emerging any time soon. Chinese officials have recently taken aim at the unprecedented coronavirus stimulus in the United States, which has seen American debt levels balloon and stoked concern in Beijing about the devaluation of the US dollar assets held by Chinese financial institutions. Threats by the US to sanction China over its imposition of a national security law on Hong Kong have also ratcheted up anxiety about being cut off from the US dollar-dominated SWIFT international payments system. Zhou Li, a former deputy director of the Communist Party’s International Liaison Department, issued a strong warning on the US dollar’s international monopoly last week. In a wide-ranging article, Zhou outlined the potential risk posed by the US Federal Reserve’s unlimited quantitative easing programme to China’s US dollar-denominated assets and urged leaders to prepare for decoupling, because the US dollar “has us by the throat”. His remarks have been echoed elsewhere in Beijing in recent months. Guo Shuqing, chairman of the China Banking and Insurance Regulatory Commission, captured the growing frustration in a speech at the Lujiazui Forum in June, saying US policy that failed to consider the spillover effects on the rest of the world would “overdraft the credit of the US dollar and the US”. China has long had an issue with the perceived “exorbitant privilege” of the US dollar, which is the bedrock of the global financial system and underpins the lion’s share of international trade and cross-border financial transactions. But amid deteriorating bilateral ties between the two nations and a global economic downturn caused by the pandemic, the issue has taken on new momentum. To prevent a crunch in global US dollar funding markets that would hamper credit supply to households and businesses in the US and abroad, the Federal Reserve has committed to pumping trillions of US dollars into the US economy through unlimited bond buying, emergency lending programmes and cutting interest rates to near zero. It has also opened US dollar swap lines to serve as a liquidity backstop for 14 foreign central banks, although the People’s Bank of China was not included. The stimulus package has seen the Federal Reserve’s balance sheet surge to a record US$7.1 trillion in May from US$4.2 trillion in March. While the policy response to the Covid-19 crisis was considered to be speedy and impressive, it may not necessarily be a long-term positive for the US dollar under a ballooning deficit and amid the risks of deglobalisation, according to some observers. At stake is the huge amounts of US dollar-denominated assets held by China’s government and overseas citizens. Over half of the Chinese central bank’s US$3.1 trillion worth of foreign exchange reserves, the world’s largest holding, is believed to be in US dollars. China also holds over US$2 trillion of outbound investment stock, the vast majority of which is located in developed countries and denominated in US dollars. Though the attitude in Beijing may be increasingly wary, few Western economists believe Washington is abusing the power of the US dollar with its coronavirus response. Others point out the impact on exchange rates has so far been relatively mild. “The Federal Reserve, like every other central bank, makes its monetary policy decisions mostly on the basis of domestic considerations,” said Eswar Prasad, the former head of the International Monetary Fund's China division and now a trade professor at Cornell University. The fact its actions “reverberate around the world” are simply a consequence of its policy mandates, which are purely domestic in nature, Prasad added. Continued expansion of US monetary policy amid a protracted global recession is also likely to be positive for the real world economy, and particularly for economies with current account deficits and significant amounts of US dollar-denominated debt, according to analysts. Given the US dollar shortage that emerged with Covid, a weaker dollar is still good for the world, relieving funding pressures in both developed markets and emerging markets Steve Englander, Standard Chartered “Given the US dollar shortage that emerged with Covid, a weaker dollar is still good for the world, relieving funding pressures in both developed markets and emerging markets,” said Steve Englander, global head of North America macro strategy at Standard Chartered Bank. Reform of international monetary policy is likely to take a back seat to efforts to stabilise the global economy from the coronavirus pandemic. But even in the long-term, it is not clear what shape that would take. “In fact, the Fed’s apparent magnanimity in allowing other countries to have access to dollar financing collateralised by their holdings of US Treasuries will pull countries even deeper into the clutches of the dollar,” Prasad said. A major obstacle is still the absence of an alternative reserve currency, Prasad said. China’s own push to internationalise the yuan has faltered over the past decade, despite its growing economic clout. The most recent figures from the SWIFT system showed that the Chinese currency accounted for just 1.66 per cent of international payment transactions in April versus 43 per cent for the US dollar. Fang Xinghai, vice-chairman of the China Securities Regulatory Commission, said last month that China’s ability to reduce its reliance on the US dollar would be greatly enhanced if it can boost the international usage of the yuan. A debate about the merits of the US dollar as the major reserve currency is likely to re-emerge after the coronavirus, according to Englander, especially when the liquidity was no longer needed. "[But] the question is which currency do you trust to replace it and what improvement would that make.”