Sinodollars, strategically using the system
USD system utility, surpluses = control, capitalism on the spectrum
How it started
The market became fixated on de-dollarisation themes between 2021-25 primarily because of Biden-era policies that exacerbated the fundamental cracks in the system. The debasement view was fuelled by rampant inflation and a Fed willing to risk long-term inflation credibility on a post-lockdown recovery. The fiscal sustainability fears were inflamed by the combination of $4.68trl in new deficits created and the rise in bond yields driving interest rate burden from 5.3% in FY 2020 to roughly 13.8–14% of budget in FY 2025.
This would have been a disaster for the US dollar if it was the only country undermining its long term fundamentals. Sadly, these fiscal risks were taken across the developed world, and many EM countries saw fiscal deterioration due to declines in tax revenue, China in particular. This led to the relative story playing out on the fields of growth and innovation, rather than hard money credentials.
Even more important than relative reserve currency economic fundamentals, issues of dependency occupied the minds of policy makers post-Covid. Supply chain vulnerabilities became the primary focus. This was then further exacerbated by Russia invasion of Ukraine, triggering a wide spread sanctions regime. The sanctions regime and FX reserve custody risk were suddenly driving national security strategy by those least aligned with the US & Europe.
Four years of intense geopolitical manoeuvring and China is still no further down the de-dollarisation path than any other BRICS member. A flurry of digital currency projects, a strategic effort to hoard gold and make HK/Shanghai the global centre for metals trading, and a few token efforts to switch to RMB invoicing with client states have brought China no closer to its goal of RMB internationalisation.
Demand for CGBs has wained, non-Chinese bank assets, staff, branches inside China have all stagnated or declined over the past 4 years. It turns out global markets will always prefer a free-floating, highly liquid, low reg/high utility currency over fear of debasement risk.
Introducing Sinodollars
So how does China transition now? Firstly, let’s refresh on the risks that theoretically drove the strategic concerns.
Sanctions. If sanctions are aimed at companies, rather than country, they are more manageable. Companies can be cordoned off, replaced, sacrificed. National sanctions are what must be avoided.
Asset custody risks. SAFE has steadily shifted its USD asset holdings from US Treasury custody to Euroclear and Clearstream, so that custody risk is more or less 50/50 now between the two legal regimes. On Euroclear, at least SAFE sits on the Board as a 7% shareholder. It hasn’t mitigated custody risk overall, but it has mitigated unilateral action risk by the US.
Facilitating the exorbitant privilege. With the onset of disinflation, China borrows at the lowest yields globally, rendering the relative borrowing cost issue a mute point in this global rivalry.
This process of transitioning custody risk to Belgium & Luxembourg has undoubtedly been instructive to China, as it highlights the difference between US treasuries as an investment asset vs a collateral asset.
