The Dollar “Has Us By The Throat”: Chinese Official Urges Gradual Decoupling Of Yuan Ahead Of ”Full-Blown Escalation”

With all eyes on Trump's Tuesday evening Rose Garden speech which unveiled that he'll sign new and punitive measures indirectly targeting China — namely the Hong Kong Autonomy Act, a bipartisan measure to penalize banks that work with Chinese officials found to be interfering in Hong Kong affairs — it remains that arguably the most important recent statements out of China came not from current government officials, but from Zhou Li, the 65-year-old former deputy head of the Chinese Communist Party's International Liaison Department. He's considered an important voice who echoes the outside the box thinking and general "talk" of the communist party's diplomatic establishment.

Amid the soaring US-China tension which could give way to a military stand-off in the South China Sea, given the presence and military exercises of two US supercarriers there, Zhou Li earlier this month issued what many see as the more radical 'extreme thinking' out of the communist party: an eventual decoupling of the Chinese yuan from the US dollar.

This would be a "full-blown escalation" with no off ramp scenario. But given the tit-for-tat with Washington is likely to lead precisely to further extreme responses on both sides, Zhou's position could in the end be the final weapon Beijing ultimately and no doubt reluctantly pulls out of its arsenal. Now is the time for Beijing to begin insulating itself from “dollar hegemony and gradually achieve the decoupling of the renminbi from the US currency,” Zhou argued. “The US dollar could become a major risk issue that ‘has us by the throat’.”

He penned an article widely reported on in regional media which "predicts industrial supply chains being torn up, a China-U.S. decoupling and a world split into dollar and yuan economic blocs." This would take China, contrary to President Xi's ambitious plans for his country as an expanding global economic power, into a 'forced' unprecedented level of isolation.

“By taking advantage of the dollar’s global monopoly position in the financial sector, the US will pose an increasingly severe threat to China’s further development,” Zhou wrote in the article originally published by the Beijing-based think tank Chongyang Institute for Financial Studies at Renmin University.

Framing what's at issue behind the former high ranking diplomat's rationale, The South China Morning Post summarized:

The US had been able to leverage the dollar-dominated SWIFT international payments messaging system to extend “long-arm jurisdiction” for its policies outside America, including sanctioning Russia and Iran, Zhou noted. Sanctions against energy suppliers could jeopardise China’s energy security, he warned.

And further: "China must accelerate the internationalization of the yuan, speed up the increase in cross-border payments and clearing arrangements for the yuan, establish local currency settlement mechanisms with more countries, and create conditions to maximise the use of the Chinese currency in global industrial supply chains, Zhou said."

Broadly, in this most dire scenario spelled out by Zhou, decoupling would only be possible should a ripple effect of 'walling off' in other Chinese sectors also be aggressively pursued and in progress.
Via Reuters: Chinese Vice Premier Liu He and U.S. President Donald Trump shake hands after signing their "phase one" trade agreement at the White House in Washington on Jan. 15, 2020.

"Beijing should seize the opportunity to build China-centric regional industrial chains, given the continued devastation to overseas demand and the disruption of global supply chains caused by the coronavirus," SCMP wrote of his words.

"In addition, Zhou warned, China should brace for a worldwide food crisis and the return of international terrorism during the pandemic," the report also noted.

* * *

In a brief outline presented separately by Nikkei, Zhou's position is that the Chinese must prepare:

1. For the deterioration of Sino-U.S. relations and the full escalation of the struggle.

2. To cope with shrinking external demand and a disruption of supply chains.

3. For a new normal of coexisting with the novel coronavirus pandemic over the long term.

4. To leave the dollar hegemony and gradually realize the decoupling of the yuan from the dollar.

5. For the outbreak of a global food crisis.

6. For a resurgence of international terrorism.

Again, such a grim position forecasting isolation is nowhere near the official Chinese Communist Party line, but represents a predicted necessary future reaction to full-blown long lasting conflict with the US.

The dollar is one of several reserve currencies, forming ~60% of the reserves of the world's national treasuries. The euro is ~20%. The principal reason the euro's only ~20%? EU member countries are responsible for their own bonds. Nobody wants Greek bonds and the potential haircuts in the event of default. There's an excellent Quora response that laid out the reasons why reserve currency status isn't all it's cut out to be:

First off, let’s get rid of one misconception that you seem to share with dozens of other people on Quora. The dollar is not “the world’s reserve currency.” It is “the world’s major reserve currency.” Any currency can be held as a reserve currency. There are no laws about this and it’s up to each country to decide what they want to hold, of course. Nobody declared that each country has to hold the bulk of its foreign exchange reserves in USD, it’s just the result of individual decisions by each country.
As far as we know, the dollar accounts for 63% of reserves, EUR is 20%, and then there are the rest. Take a look at the IMF’s breakdown of reserves by currency at http://data.imf.org/?sk=E6A5F467...
So why is USD the world’s major reserve currency? Why have most countries elected to hold the bulk of their reserves in USD? To fulfill this role, a country has to have:

large, liquid financial markets capable of taking huge investments (there are currently at least $6.3tn – that’s trillion dollars -- in reserves held in USD, and probably closer to $7.2tn);
a reputation for safety and rule of law, so that other countries are willing to invest billions and billions of dollars in that country’s government securities; and
a willingness to run current account deficits indefinitely, since that’s the counterpart of a financial account surplus. (I’ll explain this later)

I think you’ll find that at the moment, there is only the US that fits all three criteria, and I don’t see any other country volunteering to take its place any time soon. What other country’s bond market could take even half that amount? As far as I know, only Japan, and they have shown zero interest – in fact significant negative interest – in having their currency play this role. (Negative interest = they discourage people from doing this.) The Chinese government bond market is also large and growing, but of course China has an estimated $1tn or more in USD reserves – where can it put that money besides USD?
On the contrary, most countries fight to prevent their currency from being held as a major reserve currency, since that causes the currency to appreciate, dampens growth, and causes unemployment. That’s what all this “currency wars” talk is about. Here’s why:
In order to accumulate foreign exchange reserves, central banks buy assets (mostly government bonds) denominated in the currencies of other countries. In this case, we have foreign central banks buying billions and billions of dollars worth of US government securities. This causes the US to run a financial account surplus. (A financial account surplus means foreigners buy more USD-denominated assets than US-based investors buy in foreign assets.)
If the US runs a financial account surplus, by definition it has to run a current account deficit, unless the government intervenes heavily. The current account is mostly made up of trade in goods & services. (That’s because money coming in has to equal money going out.)

So the fact that the USD is the world’s major reserve currency is one of the main reasons why the country has run a current account deficit for most of the last 30 years. (This by the way is known as the Triffin dilemma
— a dilemma identified in the 1960s by the economist Robert Triffin, who realized that any country that dominated world FX reserves would have a consistent current account deficit that would gradually undermine the value of that currency.)
To put it in simpler terms, if the USD weren’t the world’s major reserve currency, probably its value would have fallen, US exports would be more competitive, and more people in the US would have jobs making goods for exports. On the other hand, probably fewer people in China, Germany and Mexico would have jobs making things for export to the US. Do you think that’s a good thing or a bad thing? Probably your view on this depends on whether you work in a factory in the US or China.
While some people have said that the use of the dollar as the world’s major reserve currency is an “exorbitant privilege,” other people argue that it’s actually an “exorbitant burden” for just this reason. See this article by Prof. Michael Pettis, An Exorbitant Burden
or this one on his blog, The Titillating and Terrifying Collapse of the Dollar...Again

So we can see that:

The USD is not going to lose its position as the world’s major reserve currency any time soon, for a variety of reasons, the simplest of which is that there is no possible alternative under the current monetary system;
It’s virtually inconceivable that it could lose its position as a reserve currency totally; and
It might be a good thing for the US economy – or at least the average US worker – if it did lose that position. As several people here have pointed out, GBP used to be the world’s major reserve currency. It’s now a relatively small part of global reserve (4.5%). Yet life seems to go on OK in Britain.

Footnote: By the way, let me explain a bit why the euro can’t fulfill this role. The problem with the euro is that there are no eurozone bonds, there are only national bonds (i.e., bonds issued by the individual countries). Now remember, why does a country issue bonds? Because it has a budget deficit. Therefore, the largest national bond markets are going to be those of the countries with the largest government deficits. These are precisely the countries whose bonds you don’t want to buy. So within the eurozone, the biggest bond market is the perennially fiscally challenged Italy (EUR 2.4tn outstanding), followed by France (EUR 2.09tn). By comparison, there’s only EUR 1.3tn in German bonds outstanding, not far above the EUR 1.23tn for much smaller Spain (49mn people vs 81mn. So the problem with the euro is not the lack of EUR-denominated assets, it’s the lack of attractive, trustworthy EUR-denominated assets.

No matter how indebted the US government gets, at the end of the day the US Treasury and the Fed are going to work together to avoid defaulting. Not necessarily so with the euro, as we’ve seen with Greece — the ECB and the other EU countries won’t necessarily bail out Italy if it can’t pay its bills.

The Swiss definitely don't want their franc to be a reserve currency. In the 1970's, they imposed a 41% tax on Swiss franc accounts opened by foreign depositors. Today, they have a central bank rate of -0.75%, meaning countries that want to hold their reserves in Swiss francs must pay the Swiss central bank for the privilege.

I had a friend who worked for SWIFT in Belgium... and after the Democrats (NYT) attack on SWIFT he was brought back to the States and was a “contractor” at State.

SWIFT is populated by banking and intelligence agency people’s from whatever Nation they come from to work there.

This is an excellent summation of the actual crisis that China faces but puts a rosy outlook from a Chinese perspective;

The Chinese currency has only recently ever stabilized as a defacto currency with a normal “international valuation”. China manipulates the value much the United States’ objections since Nixon opened the doors. Chinese banks give loans small emerging nations cannot afford to take or say no.... These predatory lending practices result in taking over ports and valuable land rights.

China has few friends who are going to help them “openly”. There will always be the sanction busing French/German/Italians/Belgium European countries who sell and trade illegally with the leapers of the international community.

Trump did yeoman’s work with North Korea that initially had huge implications for the Iranian and Syrian arms and Nuclear programs, but also had a decoupling component from China in the offing.

If China wants to play military games, they may well see how quickly they are blinded in communications warfare as a small taste of American power to completely blind them... or we may do it first.

Some of my work history was as the Admin NCOIC/Steno CINC in Korea in the 80s and the Chief JUSMAG-K, and also as the SGS NCOIC for again for XVIII Airborne Corps. Even earlier I was an airborne infantryman turned Steno for the Commander of the 82d Abn Div in mid to late 70’s. I am pretty sure I know what I’m talking about being privy to America’s military top echelon’s and in the foreign service later — mark my words that if a Nation is Blind and they cannot see, and it cannot communicate, then it cannot defend or have any command and control.

China has no game - they’ve played their conventional military hand and they are not better than Russia or France for that mater.

America is the most decent nation on the planet from which to live or to serve mankind - America is the land of the free and maybe someday the world can follow our ways to a better life.

When it comes to Korea, Japan,

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