It’s All about Networking: The Limits of Renminbi Internationalization
Commentators are yet again speculating about the demise of the U.S. dollar and the rise of China’s renminbi. In December, President Xi Jinping told Gulf leaders that China would try to buy oil and gas in renminbi. Last month, President Vladimir Putin met with President Xi and called for wider use of the renminbi for trade settlement between Russia and Asian, African, and Latin American countries; Association of Southeast Asian Nations (ASEAN) finance ministers and central bank governors met to discuss ways to reduce dependence on the U.S. dollar; and Brazil and China agreed to carry out bilateral trade and financial transactions using their local currencies.
A Confused Debate
The debate about de-dollarization and renminbi internationalization is often muddled. Some analysts make maximalist claims about whether the dollar’s dominance will persist or perish. Others make claims about incremental progress in de-dollarization, often rebutted by those reverting to maximalist claims. At times, it seems commentators are talking past each other.
There are at least two questions—with different thresholds—behind this debate. The first question is about high-threshold internationalization: Can the renminbi overtake the U.S. dollar worldwide across currency functions to end dollar dominance? Many experts argue—correctly—that this level of renminbi internationalization is extremely unlikely and would require major changes to China’s economy, including an open capital account and probably a sustained current account (trade) deficit so that other economies could accumulate renminbi-denominated claims on China.
The second question is about low-threshold internationalization: Can China encourage enough trade settled in renminbi to boost its currency’s standing as a bilateral currency and to reduce its reliance on the U.S. dollar? The answer to this second question is, yes, at least at the margins. Indeed, this seems to be already happening.
The implications of these two questions and outcomes are very different. If the high-threshold question were resolved in the renminbi’s favor, China’s global financial and economic influence would substantially increase, and the United States’ would diminish. Of course, how this could happen is another question. It would likely require massive economic mismanagement by Washington to sufficiently erode confidence in U.S. dollar assets and the U.S. financial system. But if the low-threshold question were answered in the affirmative, China could still exert more influence over its trading partners and mitigate risks from potential U.S. financial sanctions.
Networking, Networking, Networking
A crucial determinant of whether the renminbi can go beyond low-threshold internationalization will be whether it can achieve sufficient network effects to be used in transactions not involving Chinese entities. Economists define network effects as the attractiveness or value that a currency derives from its existing usage by individuals, firms, and countries. These benefits are non-linear, as the more a currency is used, the more entities will be willing to use it with other entities. Widespread use of a currency as a means of settling transactions reduces the costs of using that currency, and market actors would face costs if they tried to use an alternative, especially after the leading currency has achieved a critical mass of users. For this reason, leading currencies tend to benefit from self-reinforcing cycles of dominance. Within a single country, network effects are nearly automatic for its legal currency. But internationally, only a few currencies are used sufficiently to fully benefit from network effects, most notably the U.S. dollar and the euro.
Network effects are vital for full currency internationalization almost by definition. An international currency is not merely one that is used beyond the border of the issuing economy but also one used for transactions between nonresidents of that economy. To achieve this, nonresident entities must be willing and able to settle transactions with each other even if the issuing economy is not directly involved. In other words, while many foreign firms or banks may be willing to settle transactions with Chinese entities in renminbi, China’s currency will not be truly internationalized until it is readily accepted by, say, Brazil to trade with South Africa.
The U.S. dollar dominates global trade settlement and invoicing far beyond the U.S. economy’s share of global output. Unfortunately, high-frequency data on global trade invoicing by currency is not available. However, the available data shows the dollar’s dominance over the past two decades in all regions except Europe. High-frequency data from SWIFT indicate that the renminbi accounted for only 2.2 percent of global payments—for all types of transactions—as of February, a share which has barely changed over the past few years. However, the renminbi’s share of trade credit—lending to facilitate the cross-border movement of goods—increased to 4.5 percent in February from 2 percent a year earlier.
Most talk of expanding renminbi usage for trade is among developing countries. This is likely because those countries are most reliant on China for exports and most concerned about the “excessive” use of Western financial sanctions. Key advanced economies, on the other hand, are aligned against Russia and coordinating sanctions, while sharing concerns to varying degrees about China’s strategic intentions.
China is settling more trade in renminbi—this share jumped to roughly 23 percent of China’s total goods trade as of the first quarter of this year. However, it remains well below its peak in 2015, after which China’s exchange rate devaluation and subsequent strengthening of capital controls reduced many businesses’ willingness to settle in and hold renminbi. China’s central bank does not report the countries with which China is conducting trade in renminbi, but the increase in 2022 was likely because of Russia and perhaps a few other countries preferring the renminbi due to Western sanctions. Firms in advanced economies—which account for 57 percent of China’s trade—are already interested in using renminbi to settle trade with China. For example, during the first half of 2022, nearly a third of UK-China trade was settled in renminbi.
While more of China’s bilateral trade is likely to be settled in renminbi going forward, China’s bilateral trade is not sufficient to approach the U.S. dollar’s share of trade settlement. That would require true internationalization, with countries besides China using renminbi to trade with each other.
For market and geopolitical reasons, it is hard to imagine advanced economies trading with each other in renminbi, and it is only slightly less implausible that advanced economies would switch to the renminbi for trade with emerging market and developing economies (EMDE) besides China. Those two groupings of trade flows account for 47 percent and 19 percent of global trade, respectively, based on IMF data. Currently, there is little evidence of renminbi-denominated trade settlement that does not directly involve China, except possibly between Russia and a few other countries. If it were to happen, some EMDEs would likely be interested participants
Beijing has been pushing renminbi internationalization for over a decade, but Chinese officials have had to balance this goal with political imperatives to maintain financial and exchange rate stability in part through capital controls. The more renminbi assets there are offshore beyond the controls, the harder such financial management becomes. Consequently, Beijing’s renminbi push has been cautious and focused on bilateral uses, not true internationalization. Although China’s central bank has a network of currency swaps with other central banks, these are intended to facilitate bilateral trade with China, not between third countries.
The implication is that China’s currency is unlikely to achieve widespread network effects absent a change in Beijing’s renminbi internationalization strategy and substantially more offshore liquidity in renminbi. Beijing’s interest in inking new deals for renminbi-based bilateral trade does not overcome this fact.
For example, talk of renminbi-denominated oil trade has spurred speculation of the “petroyuan” overtaking the “petrodollar.” But if Saudi Arabia—China’s top source of imported oil—accepted renminbi for all the oil it sells to China, renminbi-denominated oil futures contracts would only account for 7 percent of the global total. If China and Saudi Arabia settled all their bilateral trade in renminbi, the renminbi’s share of worldwide trade settlement would increase by about 0.2 percentage points, based on IMF data. Even if all of China’s bilateral trade were settled in renminbi, that would only bring its share of global trade settlement to 12 percent, far below the dollar’s share.
Think Bilaterally, Not Globally, at Least for Now
Claims that the renminbi will or will not replace the U.S. dollar could both be right depending on how the question is framed. The renminbi is internationalizing, but only in the bilateral or low-threshold sense. It will not replace the U.S. dollar globally, but it is already starting to replace the dollar in some of China’s trade relationships. Whether it goes further and reaches something closer to full, or high threshold, internationalization is in part Beijing’s choice.
This kind of renminbi internationalization may achieve Beijing’s goals, including reducing China’s exposure to exchange rate fluctuations and mitigating China’s vulnerabilities to U.S. financial sanctions. Such progress is only incremental, as major Chinese banks are still largely reliant on the global dollar network for international finance and SWIFT for messaging international payments. Still, policymakers should not confuse maximalist claims about unassailable dollar dominance with Beijing’s more modest goals.
Gerard DiPippo is a senior fellow with the Economics Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Andrea Leonard Palazzi is a research associate with the Economics Program at CSIS.