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China's digital FX aspirations and US dollar dependency: Valid or just propaganda?

3 June 2021

Capital controls are an effective, if coercive method of controlling business activity, personal spending and investment opportunities and are notoriously the darling of illiberal regimes with stagnant economies and in which a merry-go-round of coups which topple leaders and leaders which topple coups usually dominate their governance.

Over the past 75 years, there have been stagnant national economies which rely on the manpower of the people to fuel the lifestyle of one leader, almost all of which have collapsed or resulted in civil unrest. That may well be the case with some of the republics in South America and South East Asia, but China is an absolute anomaly.

The Chinese monetary system and the ability of the country's 1.4 billion citizens to use it internationally or with any degree of free enterprise is no different in its basic structure to that formed by Vladimir Lenin over 100 years ago, however its dominance on the world stage is tremendous, despite its strictly controlled nature.

China has strict capital controls, its central bank is a division of the communist government representing a single party state, and is absolutely opposed to any form of alignment with the free market economies of the west.

Despite this, there is a distinct view that has emerged over the past week relating to how the United States government perceives its own ambitions for the Yuan, China's national currency which is a reserve currency despite its completely restricted nature.

In retrospect, perhaps it was not a laughing matter when Chinese officials suggested the Yuan become a reserve currency, as this may well have been part of a clever move for China to maintain control within its own jurisdiction whilst at the same time harbor aspirations of control greater than its borders. Just as last week came to an end, many interbank FX dealers formed the opinion that Chinese exporters have recently remained reluctant to hedge their burgeoning US dollar-denominated revenues, despite a strengthening Yuan and a warning from the country’s foreign exchange regulator telling them to pay more attention to the management of currency risks.

George Sun, Head of Global Markets for Greater China at BNP Paribas, one of the world's longest established Tier 1 FX interbank dealers told mainstream media last week “We see some Chinese exporter clients that have a lot of dollars, and we ask them why don’t you hedge some of this?"

In congruence to this, China has played down those concerns held by the United States government about its ambitions for the Yuan, with the new deputy governor of the People’s Bank of China (PBOC) insisting “our goal is not to replace the US dollar or any other international currency”.

Mr Li Bo, who holds that position, has taken the official stance that contrary to creating an internationally-available digital Yuan to replace the US Dollar in trade settlements, the efforts to create a digital yuan are aimed at domestic use.

Official lines from communist officials are often laced with propaganda, however it is entirely plausible that one of the main drivers behind creating a digital Yuan is to further control the use of internal capital by Chinese citizens as well as to be able to exert control over the buying habits of those living within the boundaries of the People's Republic rather than to create a means of conducting business internationally with the Yuan, as this would be against the ethos of the fiscal policy of the country.

Two weeks ago, Mr Li Bo spoke on a discussion panel about this, stating “For the internationalization of the renminbi, we have said many times that it’s a natural process, and our goal is not to replace the U.S. dollar or other international currencies. I think our goal is to allow the market to choose, to facilitate international trade and investment.”

Mr Li Bo did allude to the potential testing of the digital Yuan on a cross-border basis at the 2022 Winter Olympics which are scheduled to be held in Beijing, however that is very much likely to be a one-off to showcase the ability of Chinese developers.

History has taught many observers that government-controlled regimes often use national events to show their might, yet do not allow the use of what is being showcased by the general public. Thus, the US Dollar is likely to be the de facto FX settlement instrument for cross-border Chinese business for quite some time, and the digital Yuan no more than a surveillance tool for the state on an internal basis.

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