US-China decoupling: is Beijing ramping up its diversification away from the US dollar?

Frank Tang
·4 min read

China may be speeding up the diversification of its foreign exchange reserves away from US dollar assets in response to potential American financial sanctions, but there are clear limits on how far it can go in its de-dollarisation push, according to analysts.

China has long tried to undermine the US dollar's dominant role in the international monetary system, despite the fact that the bulk of its reserves are in dollar-denominated assets.

But amid fast deteriorating bilateral ties with the US, including the threat of financial sanctions, debate about reducing dependence on the world's largest reserve currency has taken on new urgency in China.

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Beijing cut its holdings of US government debt for three consecutive months to US$1.07 trillion in late August, the lowest level since March 2017, according to data from the US Department of Treasury.

The State Administration of Foreign Exchange (SAFE), China's foreign exchange regulator, does not publish information on reserve holdings because it is regarded as a state secret.

However, the agency said in its most recent annual report that US dollar assets accounted for 58 per cent of reserves in 2015, unchanged from a year earlier.

If China has maintained the same spread since then, US dollar assets would account for about US$1.8 trillion of China's total reserves of around US$3.14 trillion, according to calculations by the South China Morning Post.

But there are signs China might be ramping up diversification of its reserves portfolio.

China's purchases of Japanese government bonds hit a three-and-a-half-year high this year. From April to July, China snapped up 1.46 trillion yen (US$13.82 billion) worth of bonds - 3.6 times more than a year earlier, The Nikkei reported, citing data from Japan's Ministry of Finance and the Bank of Japan.

The Global Times, a nationalist Chinese tabloid, reported last month that China could cut its holdings of US Treasury bonds by 20 per cent to US$800 billion, citing analysts.

Still, analysts are divided over whether Beijing is continuing with moderate diversification or is embarking on a new plan to rapidly cut US dollar holdings.

Tan Yaling, president of the private think tank China Forex Investment Research Institute, said changes to China's foreign exchange reserves were part of "a process of diversification" adopted years ago by the foreign exchange regulator.

"We shouldn't pursue a radical approach to de-dollarisation - it does no good," Tan said.

SAFE did not reply to requests for comment, but it said in its 2020 plan it would prudently push forward with diversification of reserves.

With the US now viewing China as a strategic competitor, Chinese academics believe friction with the US could lead to financial sanctions and decoupling - and many warn Beijing must prepare.

He Qing, from Renmin University of China, said at a seminar last week that "if China's access to the US dollar is restricted, it would impact China's overseas investment, foreign exchange reserve operations and lead to larger fluctuations of the yuan exchange rate in the short term".

Some Chinese researchers argue the US dollar's role as the primary currency for international payments is cracking.

Wang Wen, the executive dean of Chongyang Institute of Financial Studies, a think tank at Renmin University, was quoted by Chinese magazine Globe last week as saying monetary easing by the US Federal Reserve is undercutting confidence in the US dollar as the world's dominant currency.

At the same time, the absence of a practical alternative continues to hold back Beijing's efforts to move away from the US dollar.

"The role of the US dollar may weaken in the long run, but for now, what other currencies can you choose?" said Ding Shuang, chief Greater China economist of Standard Chartered Bank.

This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2020 South China Morning Post Publishers Ltd. All rights reserved.

Copyright (c) 2020. South China Morning Post Publishers Ltd. All rights reserved.