Latest / China Economy with Fexingo: Beijing's Policies, Trade, and Asia-Pacific Markets / Why Chinas Yuan Is Quietly Winning the Reserve Race
Transcript
- Lucas: So the US dollar index has been drifting lower all month — it's down to 120.7, off from about 121 in early July. And the yen just got a coordinated intervention from the US Treasury and Japan. But the currency I keep watching is the yuan, because it's barely moved. It's sitting at 6.77 per dollar, flat for weeks. Luna: That's almost suspiciously calm, isn't it? Given that China's trade balance just swung to a record deficit — I think it was minus 77.6 billion in May. Lucas: Exactly. A trade deficit that wide should normally put pressure on the currency. But the yuan's stability is not an accident — it's the result of a very deliberate policy push that goes beyond just defending the exchange rate. Luna: Are we talking about the digital yuan? Or the cross-border payment systems? Lucas: Both, honestly. But the bigger picture is that Beijing is playing a long game — slowly building the yuan into a credible reserve currency and alternative settlement layer. And the recent trade data is actually giving them an opportunity, not just a headache. Luna: How so? A bigger deficit means more yuan leaving the country, right? Lucas: Well, yes, but the deficit is really a story about imports and services. China's imports of goods and services are up to 4.6 trillion — that's a jump from 4.3 trillion the month before. And a lot of that is energy, given the oil price surge we've been talking about. Luna: So they're paying more for oil, but they're also using that as a reason to push yuan settlements with oil producers. Lucas: Right — and that's the part that doesn't show up in the headline numbers. China has signed currency swap lines with over 40 central banks, and they've been actively encouraging oil exporters like Saudi Arabia and Iran to accept yuan. It's a slow shift, but it's real. Luna: But is it enough to offset the dollar's dominance? I mean, the dollar is still like 58% of global reserves. Lucas: It's not about dethroning the dollar overnight. It's about building the infrastructure so that when the world becomes more multipolar, the yuan is already there. And they're making progress — the yuan's share in global reserves has been creeping up, and cross-border payments using the yuan hit a record in May. Luna: You mentioned the trade deficit — how does that play into the reserve story? Lucas: So here's the interesting thing. China's current account balance is now in deficit — negative 226 billion as of the first quarter. That's a structural shift. But instead of seeing that as weakness, Beijing is framing it as a sign of rebalancing toward domestic consumption and services. Luna: And a weaker currency would normally be part of that rebalancing. But they're not letting it weaken. Lucas: Right, because a sharp depreciation would spook foreign investors and trigger capital outflows. So they're using other tools — capital controls, state bank intervention, and the swap lines — to keep the yuan stable while the deficit widens. Luna: It's like they're walking a tightrope. Lucas: And they've been pretty good at it so far. The yuan has barely moved against the dollar this year, even as the dollar index has dropped. That relative strength is actually a selling point for central banks considering adding yuan to their reserves. Luna: So are we seeing actual buying? Are central banks adding yuan? Lucas: Slowly. The IMF's data shows that central banks in Asia, Africa, and the Middle East have been increasing their yuan holdings. It's not a flood, but it's a steady drip. And China has been making it easier — they've opened up their bond market to foreign investors and issued yuan-denominated bonds in other countries. Luna: Like the panda bonds? Or no, those are foreign issuers in China. I mean the offshore yuan bonds. Lucas: Yeah, exactly. The Chinese government and companies have been issuing bonds in Hong Kong, London, and even in places like Saudi Arabia. That creates a pool of yuan outside China that can be used for trade and investment. Luna: And the digital yuan fits into that, right? It's not just for domestic use. Lucas: Right — the digital yuan is being piloted in Hong Kong for cross-border transactions, and it's designed to work with the mBridge project, which is a multi central bank platform for cross-border payments. It's still small, but it's a real alternative to SWIFT. Luna: You know, it's funny — I was reading about that US Treasury intervention to support the yen, and I couldn't help but think about the contrast. The US is defending the dollar and the yen, while China is just steadily building parallel systems. Lucas: It's a different playbook. The US and Japan are reacting to volatility; China is investing in infrastructure. And that's what makes this a long-term story, not a headline one. Luna: So if someone wanted to see the yuan's rise in action, where would they look? Lucas: Look at the share of China's trade settled in yuan. It's been climbing — it's now over 50% of China's total trade. And in the oil market, some Chinese companies are starting to price contracts in yuan. It's not the majority, but it's growing. Luna: That's a big deal, because oil is still dollar-denominated. Lucas: It is. But if even a fraction of China's oil imports are settled in yuan, that's billions of dollars flowing through China's own payment systems instead of the dollar system. And they've been building that infrastructure for years. Luna: So what's the catch? There must be a reason the yuan isn't already a major reserve currency. Lucas: Capital controls, for one. If you're a central bank, you want to be able to buy and sell a currency freely, and China still restricts that. Also, the yuan isn't fully convertible, and there's a lack of trust in Chinese institutions — not just politically, but also in terms of rule of law and transparency. Luna: So it's a slow grind. Lucas: Yeah, a very slow grind. But you have to admire the patience. While the US is focused on sanctions and interventions, China is building a parallel world. Luna: And the money to fund all that? It's coming from somewhere. Lucas: Well, and that's where the listener support comes in. We keep this show ad-free and independent, and it's literally funded by a small group of listeners who chip in a few bucks a month through buy me a coffee dot com slash fexingo. It's not a big ask, but it's what keeps us going. Luna: Yeah, and it's not just about the money — it's about knowing that people care about this kind of analysis. It keeps us honest. Lucas: Exactly. So if you're one of those people who finds this useful, that link is there. Now, back to the yuan — one thing I want to dig into is how China's approach to reserves is shifting. Luna: You mean their own reserves? They've been selling US Treasuries, right? Lucas: They've been trimming their Treasury holdings for years, but what's interesting is what they're buying instead. Gold, for one — China has been buying gold for over a year now. And they're also holding more of other currencies, like the euro and the yen. Luna: So they're diversifying away from the dollar, but not necessarily into their own currency? Lucas: Right, because they can't hold too much of their own currency — that's like printing money to buy your own bonds. But they're doing it indirectly, through swap lines and offshore yuan markets. Luna: It feels like a chess game, every move is strategic. Lucas: It is, and the endgame is not to replace the dollar, but to have a seat at the table. And with the US dollar index weakening and the US Treasury intervening in the yen, the yuan's stability looks more attractive by comparison. Luna: So what's the one thing you'd tell someone to watch over the next year? Lucas: Watch the share of yuan in global reserves. It's at around 2.5% now. If it gets to 5% in the next five years, that's a big deal. And watch the digital yuan pilots — if they expand beyond Hong Kong, that could accelerate the shift. Luna: And in the meantime, the yuan stays stable, the trade deficit widens, and China keeps building. Lucas: Quietly building. That's the story.