(ATF) The next time China boasts about the growing global clout of the renminbi, ask yourself why Carrie Lam is gradually disappearing under a mountain of banknotes.
The Hong Kong government’s chief executive can’t have her salary of about HK$5 million a year ($640,000) paid into the bank because, well, she no longer has an account. Since Washington imposed sanctions on Lam in response to China’s harsh new national security law for Hong Kong, no bank dares to accept her as a customer for fear of being punished by the US.
Which conjures up the memorable mental image of Lam wandering her home wondering where to stash her cash. Under the sofa, as they do in bad novels? Behind the noodles in the kitchen cupboard? Maybe she has a safe?
“I have piles of cash at home, the government is paying me cash for my salary because I don't have a bank account," Lam told local TV.
The fact that even China’s big four state-owned banks, the largest in the world by assets, are unwilling to take Lam on as a client speaks volumes about the power of the dollar. For any lender that does business with a person or entity or country under US sanctions faces the very real threat of being barred from transacting in dollars.
That would be a death sentence, in effect, for an international bank, which is why the Japanese government has reminded its banks with US operations that they must adhere to the US sanctions.
Huge fines, enormous power
It’s no surprise, then, that more than 30 banks and other financial institutions, both American and foreign, have agreed to pay big fines to the US Treasury in recent years rather than fight sanctions-busting charges and risk losing. The list is topped by French bank BNP Paribas, which paid $8.9 billion as part of a deal to settle two criminal charges of breaking US sanctions against trade with Sudan, Iran and Cuba. Next comes HSBC, which stumped up $1.9 billion.
The Treasury wields such enormous power because the dollar dominates global trade and finance, and transactions in the dollar pass through the US payments system, giving Washington jurisdiction beyond US borders.
Around 85% of all foreign exchange transactions occur against the dollar. It accounts for 61% of official FX reserves and about half of global trade is invoiced in dollars, according to the Bank for International Settlements. It is also the primary funding currency, with about half of all cross-border loans and international debt securities denominated in dollars.
The dollar doesn’t have it all its own way. The euro and the dollar were each used for almost 38% of international payments in November, but the euro’s popularity reflects cross-border trade in the euro zone. More to the point, the renminbi was only the sixth most active currency for global payments by value, with a share of just 1.66%, according to the Society for Worldwide Interbank Financial Telecommunication. Even the Canadian dollar was used more.
China isn’t sitting on its hands. As well as opening up its onshore bond and stock markets to foreign investors, China recently launched the first copper futures contract available to overseas investors. Denominated in renminbi, the contract can only help China’s efforts to spur international use of the currency.
But global currency prominence, let alone dominance, is not achieved overnight. Down the centuries, the main reserve currency has been issued by the country with the biggest economy and the most powerful military. China is catching up the US on both criteria. But while these conditions are necessary, they are not sufficient.
Jeff Bader, a national security adviser to US President Barack Obama, summed up why China is many years, perhaps decades, away from being a rule maker rather than a rule taker in international finance.
China stymied by lack of rule of law – and trust
“It lacks the foundation of rule of law, currency and capital account convertibility, an independent central bank, and deeply liquid markets that international investors seek, all of which will be necessary for it to provide an alternative to the US dollar as an international currency,” Bader said.
Trust is an important pillar of a widely used currency. After noting that the euro has failed to gain the world’s trust because the euro area is not a unitary state, Ruchir Sharma, Morgan Stanley Investment Management’s chief global strategist, added: “China’s aspirations for the renminbi have been stymied for the opposite reason: concern about the arbitrariness of a one-party state.”
The dollar will hand over the mantle of global reserve currency one day, just as it supplanted sterling during World War One. By running current account deficits, the US supplies the rest of the world with the safe asset it craves. But if America prints too many dollars, that craving might fade. Or other countries might get fed up with Washington’s bullying use of financial sanctions and establish workarounds to the US currency.
Indeed, an alternative to the dollar standard might already be taking shape, according to Dario Perkins with TS Lombard in London.
Perkins speculated that embryonic central bank digital currencies (CBDCs) might evolve organically into a digital international reserve currency modelled on the Special Drawing Right. The SDR, the International Monetary Fund’s reserve asset, is made up of a basket of five currencies: the dollar, the euro, sterling, the yen and – since 2016 – the renminbi.
“In principle, new CBDCs could be the start of something big, a radical departure from our current monetary policy regimes and – perhaps – eventually a challenge to the dollar’s dominance of the international monetary and financial system,” he wrote.
The US would not want to surrender the “exorbitant privilege” of being able to pay for imports with dollars it can create at will. “Yet it is possible to imagine such a system developing over time, especially given the dwindling role of the United States in global GDP,” Perkins added.
A digital SDR is a concept that should appeal to China because its extensive tests of a digital yuan put it well ahead of other countries in the CDBC race. Unfortunately, whatever emerges will come far too late to stop Carrie Lam’s pile of banknotes from growing ever bigger.