Latest / China Economy with Fexingo: Beijing's Policies, Trade, and Asia-Pacific Markets / How China Is Using Currency Swaps to Sidestep the Dollar
Transcript
- Lucas: China's currency war is often described as a long shot — trying to displace the dollar from its reserve throne. But Beijing isn't actually trying to dethrone the dollar overnight. They're building a parallel rail system. Luna: A parallel rail system — meaning, trade settlement channels that don't rely on dollar clearing? Lucas: Exactly. And the most underappreciated piece of that infrastructure is the bilateral currency swap line. The People's Bank of China now has active swap agreements with over 40 central banks — Argentina, Indonesia, Saudi Arabia, Russia, you name it. Combined, they're worth nearly half a trillion dollars. Luna: And the purpose is straightforward: if you're Argentina and you need to pay for Chinese imports, you don't have to source US dollars. You just draw on the swap line, get yuan directly, and settle the trade. Lucas: Right. It bypasses the entire dollar-clearing plumbing — the correspondent banking system, SWIFT messages routed through New York, the whole thing. And for a country like Argentina, which has chronically low dollar reserves, that's a lifeline. Luna: If today's breakdown of how these swaps actually work has been useful for you — if it's made something click about how China is reshaping trade finance — the way these episodes stay ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo. Lucas: Yeah, it's a small way to keep this kind of focused analysis coming without any sponsor interruptions. So — back to the mechanics. A swap line isn't charity. It's a credit line denominated in two currencies. The PBOC sends yuan to, say, Bank Indonesia. In exchange, Bank Indonesia sends rupiah to the PBOC at a pre-agreed exchange rate. Luna: So both sides hold each other's currency as collateral. That way, if one party defaults, the other isn't left holding worthless paper. Lucas: Precisely. And the agreement typically has a term — three months, six months, renewable. The interest rate is usually benchmarked to the PBOC's lending rate or SOFR. But here's the key: the swap line itself doesn't show up on China's foreign exchange reserves. It's off-balance-sheet until drawn. Luna: Which means China can expand its currency's reach without formally running a trade deficit or depleting its dollar stash. Lucas: Exactly. And the data shows they're accelerating this. In 2025 alone, the PBOC renewed or expanded swaps with Thailand, Pakistan, and Nigeria. The Saudi swap, signed in late 2023, was a landmark — because Saudi oil sales are traditionally priced in dollars. If Saudi Aramco starts accepting yuan for crude, that's a direct hit to the petrodollar system. Luna: But hasn't that been mostly symbolic so far? My understanding is that actual usage of these swap lines is still relatively low — like, less than 10 percent of the total capacity is drawn at any given time. Lucas: That's true for normal times. Usage rates spike during dollar liquidity crises. When the Federal Reserve hiked rates in 2022-2023, the dollar strengthened sharply. Countries like Argentina and Sri Lanka saw their dollar funding costs skyrocket. They drew heavily on their yuan swap lines because the implied interest rate was lower than what they'd pay in dollar bond markets. Luna: So it acts as a safety valve during dollar strength. And right now, the dollar is very strong — the trade-weighted dollar index is at 120.4, up from 119.39 just a week ago. The yuan has weakened to 6.77 per dollar. Lucas: Which makes the swap lines more attractive for importers. If you're a Thai importer buying Chinese machinery, you can get yuan from your central bank at the swap rate, which is often more favorable than the spot market. You avoid the bid-ask spread and the dollar intermediary. Luna: And from China's perspective, even if only a small fraction of trade is settled in yuan, every swap line drawn reduces demand for dollars and increases the yuan's footprint in global payments. Lucas: Right. SWIFT data from May 2026 shows the yuan's share of global payments holding around 4.5 percent. That's still far behind the dollar's 47 percent and the euro's 22 percent. But the trend is up. Five years ago, the yuan was at 1.9 percent. The swap network is part of why. Luna: But isn't there a risk for China? If a counterparty like Argentina defaults on the swap repayment, the PBOC is stuck with pesos that it can't easily use. Lucas: That's the credit risk. In practice, the PBOC mitigates it by requiring that swaps be used only for trade settlement, not for financial speculation. The Argentine central bank can't take yuan and then trade it for dollars. The proceeds have to pay for Chinese goods. And if Argentina defaults, China can demand repayment in yuan or suspend the swap. It's happened before — in 2014, China let a swap with Argentina expire after Buenos Aires failed to meet terms. Luna: So it's not a blank check. Lucas: Not at all. And the geopolitics cut both ways. Swap lines are a diplomatic tool. When the US and its allies froze Russian central bank reserves in 2022, that sent a signal to every country holding dollars: your reserves can be weaponized. Swap lines with China offer a hedgeb — not a full replacement, but a diversifier. Luna: Russia is actually a fascinating case. After the invasion of Ukraine, the Bank of Russia massively increased its yuan holdings. By early 2026, yuan made up over 40 percent of Russia's international reserves. And a significant portion came through the China-Russia swap line, which was renewed in 2023. Lucas: That's the parallel rail in action. Russia can't easily trade in dollars or euros because of sanctions. But it can trade in yuan — and China gets discounted energy imports. It's a symbiotic loop that reinforces the yuan's role. Luna: Now, critics argue that swap lines don't actually make the yuan a reserve currency because you can't freely convert it. There are capital controls, you can't buy Chinese bonds without quotas, and the offshore yuan market is still shallow. Lucas: They're right about the limitations. The yuan is nowhere near freely convertible. But the swap network doesn't aim for full convertibility. It aims for a functional alternative for trade settlement. If you can pay for oil, soybeans, and electronics in yuan without ever touching a dollar, you've carved out a significant niche. Luna: And the infrastructure is expanding. China has its own messaging system — CIPS — which is a rival to SWIFT. In 2025, CIPS handled about 1.2 trillion yuan in daily transactions, up 30 percent year over year. Lucas: The swap lines feed into CIPS. When a Thai bank draws on the swap and wants to send yuan to a Chinese exporter, the payment goes through CIPS. That builds network effects. The more participants, the more valuable the system becomes. Luna: What about the US response? The Fed has its own swap lines with major central banks — the ECB, Bank of Japan, Bank of England. But those are mostly for dollar liquidity, not for promoting dollar use. Lucas: Right. The Fed's swaps are a crisis backstop. China's swaps are a strategic push. The US Treasury hasn't directly countered them, but there's growing concern in Washington. A 2025 report from the Congressional Research Service flagged China's swap network as a potential threat to dollar dominance, recommending that the US expand its own swap network to include emerging markets. Luna: So far, though, the Fed hasn't offered swap lines to, say, Brazil or India. Those countries are turning to China instead. Lucas: Exactly. Brazil signed a swap line with China in 2023, and by 2025, bilateral trade in yuan-Real settlement reached about 15 billion dollars annually. That's small compared to Brazil's total trade, but it's growing. Luna: So where does this leave the dollar? The dollar is not going to be dethroned anytime soon. But the question is whether the yuan can carve out a 10 to 15 percent share of global trade settlement and reserves over the next decade. Lucas: That's the realistic goal. And the swap lines are the boring, technical infrastructure that makes it possible. They don't make headlines, but they quietly expand the yuan's orbit. And given the current tariff environment and the weaponization of the dollar, more countries have an incentive to join. Luna: It's almost like building a highway next to a toll road. The toll road is still faster and better-maintained, but the highway is free and has no barriers. Lucas: That's the analogy. And for now, most traffic still uses the toll road. But China is betting that over time, some drivers will find the highway good enough.