• China’s Rising Power in International Finance

    China’s Rising Power in International Finance

    A potential new reserve currency

    The rise of China’s influence on the global financial market is demonstrated by its increased capital investments in international institutions and projects. As the Chinese capital market continues to expand, its control over financial institutions like the New Development Bank (NDB) and Asian Infrastructure Investment Bank (AIIB) is also increasing. To counter the United States’ global economic power and its influence over the Chinese domestic economy, Beijing introduced various monetary policies through the People’s Bank of China (PBOC) to stabilise its currency exchange rate. 

    The US has been the dominant power in international economics since the implementation of the Bretton Woods System in 1944 when each country agreed to peg their currencies against the US dollar. The value of the US dollar was in turn pegged to the price of gold which provided a fixed exchange rate. The Bretton Woods system was widely abandoned in the 1970s and the dollar became no longer convertible to gold. Instead, the dollar became a floating currency whose value was determined by the foreign exchange market through the power of demand and supply. Even so, the US dollar is the world’s reserve currency despite its fluctuating value as many countries have pegged their currencies to the dollar to maintain a fixed exchange rate. 

    However, China in 2005 implemented a flexible exchange rate strategy to strengthen and nationalise its currency, the yuan, as a way to reduce the United States’ influence and secure its own position as the worlds’ second-largest economy. Furthermore, a digital version of the yuan has been introduced to maximise the usage and government control over it domestically and internationally. China also encouraged trade with national currencies and the Euro between China and Russia and reached a “dollar-free trade” agreement with Russia and India. The agreement requires the three parties involved to only trade using their respective national currencies, with the effects of this being the elimination of the pressure of the US dollar.   

    China’s capital and exchange market control 

    Increasing its capital investments in New Development Bank (NDB) and Asia Infrastructure Investment Bank (AIIB) in collaboration with international partners, China has further increased its multilateral presence in the global financial system. NDB is a multilateral institution jointly funded by Brazil, Russia, India, China, and South Africa (BRICS) with the objective to invest in infrastructure and sustainable development projects in BRICS, emerging economies, and developing countries. Currently, China holds voting rights and shares of registered capital in NDB equal to that of the other four founding members of the BRICS country alliance combined. AIIB was proposed by the Chinese president Xi Jinping in 2013 and launched in 2016 to support sustainable infrastructure investments in Central Asia and promote regional connectivity between Asia and Europe by working with other bilateral and multilateral development institutions. AIIB has initial capital reserves equal to USD 100 billion and includes 103 member states that each hold share subscriptions and subsequently have voting power within the institution. As the number of bought shares determines the rights to the share votes, China has become the leading shareholder with the highest percentage of voting rights (26.5%), followed by India (7.6%) and Russia (6.0%). Consequently, China is in a strong position to control and influence the actions that these organizations take. This substantial influence challenges existing rules of global governance and the international world order.

    In the global capital exchange markets, the Chinese government has implemented reforms to intensify the usage of the yuan and strengthen its value against other currencies such as the US dollar. With the introduction of the 13th Five Year Plan (2016-2020) China aimed to “steadily promote yuan internationalization and see yuan capital go global.” China has also referred to the dominance of the USD in the global capital market as an obstacle to its own and global economic stability. The internationalisation of the yuan was further extended with the usage of China’s own currency in international trade and investments. 

    One of the strategies in intensifying cross-border usage of the yuan is China’s “One Belt One Road” initiative, implemented through the trade and investment capital exchange with partners over the Asian, African and European continents. Additionally, China has introduced a digital version of the yuan, the Digital Currency/Electronic Payment (DECP), with the aim to intensify the usage of its currency and gain access to the global trade market to conduct international payments. The digital yuan has been distributed by the PBOC and fully controlled in its flow and usage by the Chinese government. Although the DECP is currently used only domestically, it is projected that in the future it will be used for international payments. 

    China’s monetary policy and currency control

    China’s “manipulation” of the exchange rate was a strategic tool during the trade war with the US. The Chinese central bank, the People’s Bank of China, implements monetary policies to strengthen the value of the yuan by managing the money supply, interest rate, and the volume of movement of the domestic currency against foreign currencies. A regulated purchase of foreign assets (US dollar, Euro, Yen, Won) in the Chinese economy determines the stability of the yuan. China initially pegged the price of the yuan to the US dollar to manage export prices. It has been trying to weaken the USD to increase its exports. This is because when the dollar is strong, US exports are expensive and its purchase power high, while a weaker dollar makes US exports cheaper and low purchase power for imported goods. 

    To overcome US tariffs, the Chinese central bank decided to reduce the value of the yuan. The devaluation of the yuan made the domestic goods cheaper, their expenditure increased, and the Chinese export became more competitive in the international trade market. Despite the risk of capital outflow, China managed to strengthen its currency value. A lower exchange rate refers to a stronger currency, meaning that it takes fewer yuan to purchase one US dollar. As China’s export increased, the inflow of the US dollar to the domestic market also accelerated leading to domestic currency demand for conversion purposes. The high supply of the yuan resulted in its value appreciation (increased exchange rate) which then made the export more expensive and the import cheaper in the long run. In response to that, the Chinese government prevented inflation by further lowering the foreign exchange rate which made Chinese exports cheaper and helped undermine US tariffs. Despite the demand for yuan in the domestic market, the PBOC has taken full control over the money supply. It set up quotas on how much money the banks can lend to keep the exchange rate stable. Another method that the central bank has implemented to boost its economy in speeding the ­­money flow is the low interest rate monetary policy which attracted more investors to borrow and invest, as well as for businesses to purchase and sell. The recent news shows that China after its initial pandemic recovery has emerged with a strong currency, while the value of the US dollar has declined. The strong currency, low interest rate policy, and lower prices of imported goods ensure the country’s steady economic growth by encouraging investors to invest in China and consumers to spend more.

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