MP Econ Issue 17: Where’s the Demand for the Chinese Yuan?

Ever since the global financial crisis, prognostications of the demise of the US dollar have come and gone. Now that the idea of a “common BRIC currency” has been floated and countries like Brazil, Saudi Arabia, and Russia are supposedly embracing the Chinese yuan to conduct trade, the drumbeat of de-dollarization has reached another crescendo.

Yet the hype cycle on de-dollarization doesn’t match the current reality of anemic demand for the Chinese yuan. While there are numerous conditions that need to be met for a currency to meaningfully challenge the US dollar as the dominant reserve currency, one of those factors is looking at who wants to hold your currency around the world.

On the demand front, the Chinese yuan does not seem all that desirable even for China’s own exporters, ~70% of whom are private. For example, exporters appear to be still keeping about one-third of their US dollar revenue (see Figure 1). This is a surprisingly high ratio compared to the early 2010s period and only marginally lower than the 2015-16 period of massive capital outflows and yuan depreciation. For the Chinese private sector, the preference for US dollars remains strong.

Figure 1. Chinese Exporters Still Keep 1/3 of Their Dollar Revenue

Source: Wind.

If the Chinese private sector isn’t terribly interested in holding yuan, what about foreigners? Foreign holdings of yuan assets actually declined by more than 8% in 2022. One could attribute this to the Zero-Covid lockdowns of the last several years that have weakened the Chinese economy. But since re-opening the economy at the end of 2022, total foreign holdings of Chinese equities and bonds have risen less than 2%.

Figure 2. No Strong Rebound in Foreign Holding of Chinese Assets Post-Reopening (q-o-q growth)

Source: Wind.

Even those that have “embraced” yuan for settling trade may be doing it out of necessity rather than having the necessary desire to do so. That seems to be the case for Russia, which settled almost none of its trade in yuan before 2022 but now has little choice under sanctions. Similarly, Riyadh may order Saudi Aramco, its state energy company, to settle oil exports in yuan. But both reflect more of a government mandate rather than private sector enthusiasm for the yuan.

So who might demand Chinese yuan? So long as China continues to run a surplus with the rest of the world—with its trade surplus currently 3% of GDP—it makes it more difficult, though not impossible, for the yuan to gain serious global traction. In short, when a country sells more than it buys, it receives net payments from foreign buyers in its own currency. That takes yuan out of the global market and depletes foreign holdings of yuan.

Figure 3. Short List of Economies That Have Surplus with China

Source: General Administration of Customs.

As such, the economies that are more likely to become a net holder of yuan are those that run trade surpluses with China (see Figure 3). That list isn’t long and includes a number of economies strongly aligned with the United States geopolitically (e.g. Japan and Australia) and therefore would be wary of widely adopting the yuan. That means realistically just a handful of economies, two of which mentioned above, might seriously consider wider use of the yuan, particularly for settling trade.

In this sense, China’s central bank governor Yi Gang is correct in stating that how far yuan internationalization progresses ultimately depends on market forces. And so far, the market has not given the yuan a ringing endorsement, despite the recent hyperbolic rhetoric.

None of this is to say that conditions won’t change to make the yuan a more desirable currency to hold by private and public sectors alike. The history of currency transitions is complex and contingent, determined by both economic and geopolitical forces. Geopolitics have certainly made a resurgence lately, though the yuan’s future status is far from preordained. I will follow up with a more considered and thorough meditation on the yuan’s prospects—and therefore the Chinese economy’s—in the near future.

Houze Song is a fellow at MacroPolo. You can find his work on the economy, local finance, and other topics here.