One consequence of the America First policies will be to create a bipolar financial world.
A glance at the foreign-exchange markets suggests that the US dollar looks as powerful and dominant as ever.
However, taking a much longer-term view suggests that this impregnable position — and the economic heft that comes with it — will come under assault.
One consequence of the America First policies of US President Donald Trump will be to create a bipolar financial world, with China at one end and the US at the other. That will mean smaller financial flows between the two, and a much more robust effort from Beijing to eventually challenge the dollar’s status as the world’s reserve currency. That, in turn, potentially has implications for everything from the status of US Treasury securities as the safest assets in the world to how oil is priced.
“The Trump administration’s “America First” policy will encourage a long-term move away from the US dollar,” according to Christopher Wood of CLSA, the arm of Beijing-based Citic Securities, pointing to “the growing American practice of using the dollar as a weapon via the implementation of sanctions and the like.”
But this more explicit weaponisation of the dollar has not only incurred the wrath of China, it is increasingly alienating government officials and politicians in Europe, the Middle East and Asia as well as infuriating some bank executives. Some of the latter believe the US has been able to impose exorbitant fines for violating US laws because authorities can threaten to lock them out of the dollar-driven financial system.
At the Milken Institute’s Asia Summit last month, former French prime minister François Fillon spoke of the need for Europe to push its currency as an alternative to the dollar in an effort to bolster European sovereignty. A world in which the dollar is the dominant reserve currency means Washington can chose to dictate policy to Europe as it has, for example, on the question of doing business in Iran. Europe has no choice but to go along or risk becoming the object of sanctions itself. Yet is it wishful thinking to believe the euro, which according to recent data from the International Monetary Fund has about a 20 per cent share of central bank reserves, can play anything but a minor role. Instead Europe, like the rest of Asia, will have to decide where its future lies — with China or a shrill but shrinking US.
When China began trading renminbi-denominated crude oil futures out of Shanghai in March, it was a signal of Beijing’s determination to eventually forge a world in which not everything is traded in dollars. At major Chinese conferences this year, government officials and the heads of some of the most important state-owned enterprises noted that domestic demand for commodities, including oil and natural gas, is so great that it makes far more sense for them to be priced in renminbi. China already uses its own currency to pay for Iranian and Russian oil. Meanwhile, transactions in the Shanghai market are up dramatically.
Monthly transaction volumes went from 623m barrels in April — the first full month of trading, to 3.4bn barrels in August to 2.7bn barrels in September, according to CLSA, citing data from the Shanghai International Energy Exchange.
Beijing’s ambitions to challenge the status of the dollar can be seen in other ways. For example, the People’s Bank of China now has foreign-exchange swap lines with at least three dozen countries. That is in contrast to the much smaller number the US Federal Reserve has.
While few have brought it up even as tensions between Beijing and Washington escalate, the inflow of Chinese money is important for the US government bond market, giving the mainland leverage if it chooses to use it. China and Japan are the two largest foreign holders of Treasuries, whose issuance is increasing as the fiscal stimulus swells the US budget deficit. Without demand from China, rates in the US could go even higher. It may not be in the mainland government’s narrow financial interest to do so but this is a time when politics is clearly in ascendancy.
At the same time, the renminbi can only become a reserve currency if it can offer the world attractive RMB-denominated investments. It is thus unsurprising that China is increasingly opening up its own government bond market to foreign investment in the hope that its increasingly liquid market can one day become an attractive alternative to the US market.
For investors who are judged on their returns in dollars — no matter where in the world they are based (and that huge group includes many sovereign wealth funds) — a world in which the renminbi becomes more important will add a layer of complexity.
When elephants joust, the mice get trampled, the saying goes. In this case, investors are the mice that may get caught in the unpredictable fallout of the tensions between the two jousting trans-Pacific powers.
This article was published by Financial Times on the 17th of October 2018.
Henny Sender is chief correspondent for international finance at the Financial Times, based in Hong Kong.