From Dollar Dominance to RMB Ascendancy: A Global Financial Shift?

The American royal family has not yet declined, but the hegemony of the US dollar has already begun to crumble. France fired the first shot for Europeans to use the RMB for settlement. During Macron's visit to China, the Sino-French liquefied natural gas transaction was settled in RMB. At the same time, before the Brazilian leader even arrived in China, they signed a local currency settlement agreement.

Furthermore, after the Russia-Ukraine conflict, it can be said that Russia has completely and thoroughly rid itself of the US dollar and openly welcomes everyone to use the RMB to buy energy in Russia. Meanwhile, Malaysia has also proposed to China the establishment of the Asian Monetary Fund, claiming there is no need to rely on the US dollar anymore. If everyone stops using the US dollar, the money released by the United States can only accumulate in its own territory, eventually destroying its own “Dragon King Temple” (a metaphor for damaging one's own interests).

White House spokesperson Pierre claimed that not using the US dollar for settlement is an infringement on the rights of American citizens. It is evident that the United States is genuinely worried this time. So, does the RMB have a chance to replace the US dollar at this moment? To answer this question, we need to start with the petrodollar. In 1973, after the collapse of the Bretton Woods system, Egypt and Syria jointly launched an attack on Israel, resulting in the outbreak of the Fourth Middle East War.

Israel is a staunch ally of the United States, and in order to deal the US a blow on the Israeli issue, the Organization of Petroleum Exporting Countries (OPEC), primarily composed of Middle Eastern oil-producing countries, decided to collectively raise oil prices, leading to the oil crisis. This ultimately resulted in the most severe stagflation period in history. At this point, the gold-dollar system had already gone off the rails, but during the oil crisis, the United States deeply realized the value of oil and began to plan to tie the US dollar and oil together.

More than half of the world's oil is produced in the Middle East. In terms of politics and economics, there are four major powers in the Middle East: Egypt, Iran, Saudi Arabia, and Turkey. However, among these four major powers, the major oil-producing countries are Iran and Saudi Arabia. Iran and Saudi Arabia are not from the same ethnic group and are even historical enemies due to religious reasons. The two countries have always been competing for religious influence. However, they have one thing in common, which is their opposition to Israel, and this is where the United States found a way to balance the two countries.

In July 1974, under the mediation and promotion of the strongman of the United States, Henry Kissinger, the US demanded that Saudi Arabia use the US dollar as the sole currency for oil trade and purchase a large amount of US Treasury bonds in exchange. The United States provided military support, giving Saudi Arabia a large amount of arms, helping train its army, maintaining the privileges of the Saudi royal family domestically, and ensuring that Israel would not trouble Saudi Arabia internationally. Since Saudi Arabia took the lead, other oil-producing countries followed suit, and the petrodollar circulation mechanism was thus established, making the world inseparable from the US dollar ever since.

However, this cycle has undergone some changes in recent decades, one of the economic reasons being that after 2010, the United States made significant breakthroughs in shale oil technology, greatly reducing the cost of oil extraction. As a result, the United States gradually transformed from a major oil-importing country to the world's largest oil producer. Consequently, various love-hate relationships have arisen between the United States and those countries with abundant oil resources.

Among them, there are pro-American countries, including Canada, the United Arab Emirates, Saudi Arabia, and Kuwait; and anti-American countries, including Iran, Russia, Iraq, and Venezuela.

In the US-Saudi relationship, what was originally an economic complementary relationship due to Saudi Arabia's oil resources has now become a competitive one. The ideological differences between the two have caused cracks in their superficial friendship. The 2018 murder of journalist Jamal Khashoggi served as a catalyst. Furthermore, with the Biden administration's advocacy for renewable energy, the relationship between the United States and Saudi Arabia has become increasingly cold.

Jamal Khashoggi

Iran is the world's fourth-largest oil reserve country, with most of its economic income coming from oil exports. However, due to Western sanctions and economic blockades, Iran's crude oil exports have plummeted, even reaching a point where it could not export normally. The purpose of the US sanctions on Iran is to make an example of Middle East and force it to comply. Iran seeks to ally with other forces to change its passive situation under continuous US sanctions. At this time, Saudi Arabia also wants to gradually reduce its dependence on the United States and oil, and both countries believe there is a huge potential for cooperation with China in the field of new energy development.

Under such circumstances, with China's mediation, Iran and Saudi Arabia have resumed diplomatic relations. This event once again proves the old saying: there are no permanent friends, only permanent interests. At the same time, many Middle Eastern countries have jumped on the bandwagon of Iran and Saudi Arabia's reconciliation: the Maldives and Iran have resumed diplomatic relations, Tunisia and Syria have reconnected, Turkey and Egypt are set to restore ambassador-level diplomatic relations, and the Houthi armed forces in Yemen are seeking reconciliation with Saudi Arabia.

The conflicts and hatred between them were originally part of the United States' plan, and a more peaceful Middle East in the future would significantly reduce the support effect of the US military on the US dollar's hegemony. Since the reconciliation between Saudi Arabia and Iran, Saudi Arabia's energy policy has become increasingly independent. The most evident evidence is the unexpected production cut by OPEC+. The oil-exporting countries' production cut was not announced at the regular OPEC meeting, catching the United States off guard. After all, US inflation has not yet decreased to a normal level, and this sudden production cut has dealt a heavy blow to the Federal Reserve's determination to bring inflation down to 2%.

We mentioned in July last year that when Biden visited Saudi Arabia, the United States wanted to persuade oil-producing countries to increase production. This would help reduce domestic inflation in the United States and decrease Russia's energy revenue. However, neither of these goals were achieved. Now, after the reconciliation between Saudi Arabia and Iran, a new round of production cuts has arrived. Before the United States could digest the fact of OPEC's production cuts, a wave of de-dollarization has begun worldwide.

Recently, more and more countries have started to use non-US dollar settlements, and in the blink of an eye, dozens of countries worldwide have signed local currency settlement agreements. It doesn't stop there. Following the US Treasury Secretary Janet Yellen's announcement of a significant increase in the US debt ceiling, sixteen countries have successively announced their plans to reduce their holdings of US Treasury bonds, seemingly slapping the United States in the face.

Adding to what we just mentioned, the old order of the United States providing security to Saudi Arabia in exchange for low oil prices is about to disappear. If the Gulf countries, represented by Saudi Arabia, are willing to allow a portion of their oil trade to be settled in RMB, exchanging oil for the transformation and development of their countries, does this mean that the internationalization of the RMB can take another step forward? Let's draw a conclusion first: the path to oil RMB, or the internationalization of the RMB, is still long.

First of all, Saudi Arabia still uses US dollars to pay for oil purchases from countries other than China. In 2022, Saudi Arabia's crude oil exports to China reached 1.75 million barrels per day, accounting for about 1/4 of its total export volume of 7.7 million barrels. However, most of its remaining customers, such as India, Japan, Europe, and others, belong to the Western camp. Even if these countries want to abandon the US dollar payment, they can use their own currencies for payment, and it is highly unlikely that they would choose the RMB as an intermediary means of payment. Saudi Arabia would not jeopardize its 3/4 market share for the sake of promoting the internationalization of the RMB.

Secondly, there is the military aspect of the United States. Gulf Arab countries, in order to maintain their own security interests, have incorporated their security affairs into the global strategy and military force protection of the United States. Countries such as Saudi Arabia, Oman, Kuwait, Bahrain, Qatar, and the UAE allow the United States to use military bases within their territories and store American weapons and equipment. For many years, the United States has maintained a military presence in the Gulf, providing security guarantees for oil-producing Gulf countries. This is, in fact, a maintenance cost for the United States to uphold the petrodollar system.

Therefore, at this stage, the relationship between oil-producing countries and the United States is not a zero-sum game of life and death. The deepening of relationships and development of multilateral diplomacy between these Middle Eastern countries and China does not mean that they will break ties with the United States. Saudi Arabia has proposed a development vision for 2030, aiming to gradually transition from oil-for-security to oil-for-development, but this process is not achieved overnight. To completely challenge American hegemony at this point, Iraq serves as the best example. As a result, the military backing of the United States will not be lifted for the time being.

Let's take a look at China and the RMB. In simple terms, the internationalization of the RMB means that it is widely recognized in overseas markets, serving as a currency for settlement and pricing, and attracting extensive holdings by foreign investors. In my new book “The Eye of Wealth,” I mention a famous trilemma in economics. The trilemma refers to the fact that monetary policy independence, exchange rate stability, and currency convertibility cannot be achieved simultaneously; only two of the three can be chosen.

We are an independent sovereign country, and an independent monetary policy is the most certain condition among these three. According to the trilemma theory, if the RMB is to be internationalized, China must either allow the RMB to be freely convertible or give up the stability of the RMB exchange rate. Unfortunately, neither of these conditions is mature at present.

First of all, the RMB is not freely convertible at this stage. From the perspective of oil-exporting countries, they often have huge trade surpluses. Holding a large amount of currency that cannot be freely converted poses significant risks. When oil-exporting countries hold US dollars, they can purchase American arms, introduce advanced American technology, and buy US Treasury bonds or invest in dollar-denominated financial products with the surplus. If these oil-exporting countries use the RMB for settlement, they also need to spend the RMB they receive.

At this stage, China's low-cost goods, large infrastructure projects, and military equipment are indeed services that oil countries can purchase. Projects like the Red Sea New City project in Saudi Arabia's Vision 2030, which involves cooperation with China, as well as supporting wind and solar power technologies and military equipment purchased at the 2022 Zhuhai Airshow, all fall within the scope of spending. However, it's important to note that in 2022, Saudi Arabia's exports to our country reached 5,193 billion yuan, while imports from our country were only 2,538 billion yuan. This resulted in a trade surplus of 2,655 billion yuan in one year. In other words, if trade between China and Saudi Arabia were to be settled entirely in RMB, Saudi Arabia would still have a balance of over 200 billion yuan each year, even if they were to spend it all.

Even if these balances allow Saudi Arabia's oil giant Aramco to invest 100 billion yuan in China recently, use more than 20 billion yuan to acquire a stake in our country's petrochemical companies, and invest more than 800 billion yuan in a large-scale integrated refining and chemical plant in Panjin, Liaoning, can they continue to invest in China using RMB?

This brings us to our second question: the control of our foreign exchange capital projects and the issue of exchange rates. We have talked about the foreign exchange control of the RMB before. Based on concerns about the safety of the capital market and the financial industry, our country allows foreign investment in our domestic capital market and securities market, but there are very strict channel controls and quota controls on the inflow and outflow of funds. In other words, not only is it difficult to transfer funds to China for investment, but it is also not very easy to transfer earnings out of the country. This naturally deters many international investors. However, without control, we would have to accept large inflows and outflows of market funds, which would result in significant fluctuations in the RMB exchange rate. This would add an unbearable burden to our country's already weak exports.

Regarding the issue of exchange rates, we actually have our own ways to deal with it, which is to artificially divide the RMB into onshore and offshore RMB. To put it simply, there are two almost completely separate markets for the RMB.

The division of exchange rates into onshore and offshore rates is a huge innovation. In this way, we can understand it as an artificially built firewall. Offshore RMB can maintain a floating exchange rate in the market and can be used for loans, investments, and other capital projects. Hong Kong and Shanghai are both trading markets for offshore RMB. To put it bluntly, this is to give foreign investors holding RMB an unregulated investment channel. Otherwise, money that can neither be spent nor invested would definitely be unwanted. However, the scale of the offshore RMB market is very limited compared to the size of China's economy, and the essential reason is that there are relatively few overseas investors willing to hold RMB.

This seems to be an unsolvable problem: the fewer overseas investors are willing to hold RMB, the less developed the offshore RMB market will be; the less developed the offshore RMB market is, the fewer overseas investors will be willing to hold RMB. At the end of March, Bank of China's Hong Kong branch successfully issued the first Hainan Free Trade Port Offshore RMB Sustainable Development Bond. So, whether Hainan can become the next offshore RMB center is something worth looking forward to.

We will find time to discuss another unresolved issue specifically related to RMB internationalization, an issue that has not been well solved by the international monetary system, including the US dollar so far: the conflict between China's domestic economic development and the export of RMB to the outside world. To make the RMB widely used in overseas markets, it needs to be as abundant as the US dollar overseas. There are only two ways to increase the number of RMB overseas.

The first is to provide RMB loans to overseas institutions and individuals. As mentioned earlier, the proportion of RMB settlement in international trade is still relatively low, which means that the RMB cannot be easily spent. At the same time, without a sufficiently mature and sizable offshore RMB financial market, international investors cannot invest their RMB. Under such circumstances, how many people will have a demand for RMB loans?

So, at least for now, the first method of spreading money overseas has very limited room for implementation. The second method of spreading money abroad is to make China's imports greater than exports, creating a trade deficit. However, the premise still requires others to agree that all our imports are settled in RMB. Even if this premise is met, what cannot be ignored is that China's advantage lies precisely in being the world's factory and in export trade, where we have always had a trade surplus, which involves a large number of jobs related to imports and exports. To force the RMB to go overseas through a trade deficit means giving up a large portion of manufacturing and export trade jobs. This is simply unrealistic in the current economic climate focused on stability.

This is actually the famous Triffin Dilemma in economics. In fact, since the US dollar became the global reserve currency, it has faced the same problem. This dilemma is also the fundamental reason for the dollar's decoupling from gold and the eventual collapse of the Bretton Woods system. Therefore, the true internationalization of the RMB is not something that can be achieved by simply signing agreements between a few countries.

The difference between the RMB and the US dollar at this stage, to be honest, is like the difference between a supermarket gift card and cash. Cash can be used anywhere, while gift cards can only be used in Chinese malls. Even though each mall has a wide range of daily necessities, gift cards still cannot be used to buy houses or make investment and financial management.