Odd Lots - Lots More on China's Moves to Create a Dollar Alternative

Episode Date: January 26, 2024

For years, people have been talking about the end of US dollar dominance or how some other currency could usurp its role around the world. But when it comes to global finance and trade, the dollar is as dominant as ever. Given the size of China's economy, the renminbi is considered one potential challenger. And in fact, China is making real moves on this front. On this episode of Lots More, we speak with Zongyuan Zoe Liu, the Maurice R. Greenberg fellow at the Council on Foreign Relations and the author of a recent article on China's de-dollarization efforts. As she sees it, the rise of a new energy and commodity system — one that is breaking away from oil — creates the opportunity for markets that are denominated in something other than dollars. Meanwhile, China, having seen Russia get cut off from the dollar system, has an increased incentive to protect itself from a similar fate. We discuss the prospects of a major change and how China could benefit, as well as the risks. We also discuss the current state of Chinese macro.See omnystudio.com/listener for privacy information.

Thanks for listening to Oddlots. Follow the show on Amazon Music for more future episodes or just ask Alexa play the podcast, OddLots on Amazon Music. If we never ever have had guests bringing treats for us and now this is two days in a row. No kidding. Yeah, this is incredible. This never happens. This is no two days in a row of guests bringing in sweets for us. Oh, that's awesome. Which makes us very popular in our row because then we'll share them with all of our colleagues. Thank you so much. Oh, that's great. I can't wait. Definitely having one of the news.

Does this bring you guys back to Hong Kong in that way? Yes. Yes. I remember every year. I actually kind of miss it like all the zodiac theme things every year. Like you would walk around the streets and there'd be all the pastries and things, but also the little gold statues in like the shape of a dog or a bear, not a bear, a pig or like a dragon and stuff. I miss that.

We don't get that so much here. Joe, do you know what you're your zodiac? Yeah. Animal is in China. And there's headphones there, but you won't. I used to know. Monkey. Monkey?

Yeah. 1980 is a monkey. Monkey and Tracy? I'm a boar. I'm very lucky. Yes. What are you? I'm a rabbit.

So this last year was my year. Oh, nice. Did you have a good year? I think so. I got it on the other day. It has to be a good year. Hi, how are you? Yeah, I just popped up out of nowhere, but I'm here too.

Harmon, what Chinese zodiac animal are you? The horse. Oh, the horse is a good one too. I did a deadlift. One, two, three. A gemini. Okay, go. What's true?

Gemini. This is an after-school special, except... I've decided I'm going to base my entire personality going forward on campaigning for a strategic pork reserve in the U.S. Where's the best with imposter? These are the important questions. Is it robots taking over the world? No, I think that, like, in a couple of years, the AI will do a really good job of making the obvious. Lots Podcast, and people are saying, I don't really need to listen to Joe and Tracy anymore.

We do have... Cha-ching. The perfect guest. Welcome to Lots More, where we catch up with friends about what's going on right now. Because even when Odd Lots is over, there's always lots more. And we really do have The Perfect Guest. I'm always sort of skeptical of like, when people talk about the end of the dollar, it sort of seems like crank stuff to me.

We have had this conversation so many times. Yes, a lot of the people who like having conversations about the end of dollar dominance, they are crank adjacent. Many of them. Many of them are firmly in crank territory. But I do think it is true if you look at what's happening in certain parts of the financial system. Like there are attempts being made. Even if they're not officially called, we are trying to move away from the dollar. They are called things like, well, we want a more resilient financial system. Or we want one where. We are not as tied or as reliant on what's happening to the dollar. Exposed. Exactly right.

So the efforts are there. They are underway. Does it mean that things are going to change in the next year? Absolutely not. I don't think so. But I don't think they can be disregarded in total. Well, in studio with us, we have someone who is definitely not a crank or crank adjacent. Former guest, Zoe Liu, you have a great piece.

China wants to ditch the dollar in Noema magazine. And, you know, this is, of course, we've done episodes on China, the dollar, whether they want to de-dollarize, et cetera. I actually find it kind of compelling. Maybe there's something going on here. Well, first of all, I do not get to choose the title. Spoken like a true journalist. All journalists have had this.

Although, I've generally been pretty involved in title. It's much less of a thing than it used to be. If you were working on a newspaper for many, many years, it was the sub-editors who would choose the headline. I'm sorry, Zoe, we've totally interrupted you and hijack the conversation. That's a talk about journalism. No, no, no, I actually do appreciate your explaining of this because sometimes I get people emailing me saying that, well, the title of your article, you are saying that China is trying to ditch the dollar. But in reality, when we finish reading our article, it turned out that you are not saying that China is going to ditch the dollar. The bottom line of my argument is that for there are economic and geopolitical reasons for countries like China to try to reduce its exposure to the dollar-based system.

And the reason I'm saying this is because just think about it. You can imagine China as the factory of the world and you are buying a lot of commodities using one currency and you are trying to sell your commodities in the same currency. this is the story of China's rights. This is how China accumulated at 1.4 trillion foreign exchange reserves denominated in dollar. But every time when Chinese exporters, importers doing a transaction, it has to go through the entire banking system, which is not denominated in the Chinese currency. This is why the Chinese financiers are grumpy about, grumpy about, right? They are saying that, well, you know, we are the largest trading partner with more than 120

country the global world and yet our currency is a very minimum. How much of the urge to maybe diversify a little bit comes from waning economic growth? And I'm very conscious that we are recording this in a week. You know, we are here on January 25th. It has been a terrible week for both the Chinese economy and its financial assets. There's been a lot of ink spilt about the crash in Chinese stocks. I think the CSI 300 index is down something like 40% over the past three years. There's a lot of conversation about structural weakness in China's economy at the moment.

How much of this urge to maybe de-dollarize as too strong a word, but sort of diversify currency options is part of this economic evolution. That makes a lot of sense, Tracy. In fact, if we go back all the way to the early 2000, that was actually the very first time when the Chinese officials was talking about, seriously talking about diversifying their foreign exchange reserve holdings. So from that time on, with the growing of the Chinese foreign exchange reserve accumulation, the conversation has been focused on how to reduce the opportunity cost of investing all the foreign exchange asset in U.S. treasuries. But things started to change around 2000, after 2000, 14. Part of the reason was because of the West's threatening of kicking Russia off the SWIFT system.

Now, at that time, the West did not go with the nuclear option with Russia, but it did sort of provide it. It did provide a wake-up call for President Putin as well as the Chinese. And one year later, it was around 2015. That was the launch of CIPS, China's cross-border interbank payment system. And at that time, again, the idea was to facilitate broader use of the RIMB in the international system. But then systematically people start to realize, well, this can be a hedge or a insurance policy. Then things really started to get worse from Chinese perspective around 2018 with the escalation of U.S.-China trade war during the Trump administration. and you have Chinese financial regulators, even the vice chairman of China's securities regulatory commission, Fang Xinai, he came out and saying that, well, we should be prepared for the so-called forced decoupling, meaning China was being kicked out of the U.S.-led global financial system.

And obviously, with Russia's invasion of Ukraine and President Putin's war against Ukraine, and the freeze of Russian reserves and kicking Russia out of the swift system, This is really the moment where China realized, you know, we could be the next Russia. And by the way, China is not the only country in the world of facing that kind of insecurity. You have countries like Saudi Arabia started to worry. And at one point, there was even floating the idea that Saudi Arabia was considering moving there, the trading or shifting part of the transactions of oil or denomiting the oil pricing in the Raminbi. So this is where I think a lot of things have been underestimated.

I'm glad you brought up oil. Actually, I should mention we talked to Zoe last year. I think it was maybe last August. She's the author of sovereign funds, how the CPC finances its global ambitions. She's the Maurice R. Greenberg Fellow at the Council on Foreign Relations. Perfect guest, literally. But actually, I'm glad you brought up oil because I thought one of the most fascinating aspects of your piece on China and the dollar. And I had never seen anyone put this together, which is that if, If China is going to be, I don't know, if it's a dominant provider of rare earth metals. And we talk about this all the time in the context of like batteries and clean tech and certain needs for high tech, et cetera. And there's, you know, there's talk about dependence on China for all these things.

If China is going to be, I don't know, maybe the Saudi Arabia of some of these commodities, then this is an opportunity to create brand new markets that aren't from day one. You know, it's like Saudi Arabia. It's like a bulkhead. Yeah. Yeah. like Saudi Arabia is like, okay, maybe after all these years, maybe it'll trade a little bit more oil and some other currency. But China could create a new market for these and not and have it be undolarized from day one. I think that is an excellent point to summarize my argument.

And I wish you were my editor. Well, your editor did a great job. It's right up at the top. Very much so. Very much so. So this is how I think about the relationship between energy and finance. Right now, we are living through a moment of the so-called energy transition, but this is actually not the very first time. We live, the human society, live through this, from fire to coal to oil.

And the next thing could be renewable or clean energy. Could it be a variety of renewable resources or clean energy sources. And the danger of this is that when we move from an oil-denominated global economy, which is about 80% of the global, economy now is fueled by oil, right? So oil is one commodity that has one single market. It does not matter where you are trading it, whether you are in Texas, you are in Dubai, or in Singapore, or Shanghai, or London. At least for most of the time, there is only one global oil market. Price change here, it moves over there. But renewables is totally different because it's a very much decentralized and distributed system. And even for natural gas is the same thing, right?

There is no single global market for natural gas. So from this perspective, this decentralized and fragmented market provide opportunity for the emergence of a different trading hub, different trading system, and different pricing mechanism. And this is where China see energy transition as an opportunity to reduce their dependence on the dollar system. And China actually has the market power in this regards because it is already one of, it is the world largest importer of a lot of commodities. And it also dominates a lot of the processing capacity for critical minerals. So from that perspective, you see China has access to the resources, has the processing capacity. They also have the manufacturing capacity in the

transition to renewables. Yeah, I didn't realize this. So I knew. I knew. China had rare earth capacity. I didn't realize it also has the tungsten capital of the world in in Ganjo. Am I pronouncing that right? Very right. In Ganjo. And it's funny because I've been to Ganjo on my way to Gwlin. No fitting. Yeah, but this was like, I mean, it must have been like 2004 or something when my mother was working in Beijing. And I, you know, I was at university at the time and rare earth metals were not on my mind. So the importance of that particular city of flew over my head at that time. But tungsten capital of the world, as you point out. The example that you pointed out is very important, Tracy, because Kanjo is the location where you, I cannot believe you actually

have been there because I have never been there. Many tourists would not even have been there. No, it was a way stop on the way to Gwai Lin. And I remember I've had a lot of adventure. in getting lost in foreign places, but this was one of the places where we genuinely got lost because we were only there for a night, and we really struggled to find a restaurant to eat in, and no one back then spoke English, and, you know, we didn't have translator apps and things like that. So I remember we went to a restaurant and we ordered something, and I think we got back, I think we thought we were ordering, like, chicken or beef, and we got, I'm pretty sure it was pan-fried scorpions in the end. This was one of my, like, only, like...

I would eat that. No, no. I would. But anyway, it was not a tourist destination, as you point out. It was really a way stop on the way to Gwai Lin, which is definitely a tourist destination and is beautiful. Very much so. But Gungzhou is important in the sense that it has China's second rare metals exchange mechanism. And the whole idea behind setting up this rare mineral exchange mechanism,

has been to increase the pricing power of the Ramin B in a lot of these critical minerals very much relevant for the energy transition and China not only have one, China not only has one, but it has another one in Nemanguu. Oh, sorry. No, I was just pointing out of the name of the city, I believe it's the Bouto Rare Earth mineral

and just a small segue about rare earth. This is another aspect of why Chinese financiers have been grumpy. They are saying that, well, you know, China is the largest rare earth mineral exporting country in the world for a lump year of the time. But they have been exporting rare earth at extremely cheap price. The idea is you sell rare earth is a very important mineral, but you sell it dirt cheap. In Chinese word, rare earth is called shi-too. It's like rare earth, earth means two. Two is like literally it means dirt.

So you are selling something precious at the price of dirt. So this is why they are really interested in sort of increasing the pricing power of their main bee. Wait, but is that just to try to get market share? Because I think about rare earths and I think finite resources, a lot of people are struggling to get them or reliable access to them. Why would you sell it cheap? That is an excellent question. For a long period of time, rare earth as a metal, it didn't have a lot of applications in the transition to renewables. Like if we were having this conversation back in, let's say, 2007, the market is definitely very different from what we are saying today. So from that perspective, yes, having market share is important, but the problem is the demand is not necessarily as high as it is today. I see. Okay, so a lot of the discussion around the shortage of rare earth metals is still very hypothetical. Very much so. Okay. Join Bloomberg in New York or via live stream on May 19th for building an AI future ready business. This event will examine how organizations are moving beyond experimentation to scale agentic AI across the enterprise.

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but also really acknowledge where you don't and find people who can fill those gaps. Listen to leading by example. example, executives making an impact on the IHeart radio app, Apple Podcast, or wherever you get your podcasts. Something that has come up on a couple of episodes we've done, but I don't think we've talked about it with you, is the Belt and Road initiative and the degree to which that has or hasn't actually been particularly effective at creating a Renminbi network or a Renminbi system.

And I think, what was it? Like, a lot of the lending is still dollarized, right, Tracy? Yeah. What is going on with that? And how do you see, like, you know, obviously the geopolitics or building relationships, of course, we've seen the emergence and growing of the formal like BRICS group of countries. How does that, how do some of these endeavors play into China's currency strategy in your view? So the Belt and the Road Initiative initially started as a way for Chinese leaders in

particular Xi Jinping to address China's domestic overcapacity problem. It's after the financial, during the financial crisis, China did the four trillion Ramin B stimulate. And then it created a lot of domestic overcapacity. Therefore, using President Xi Jinping his own word, he said, you know, China's overcapacity problem is a problem for us, but it could be beneficial for other countries. So that was the context. That was the background. But it's in reality is not necessarily how it was imagined, right? You're right. A lot of the lending have been denominated. in dollar. However, Chinese financiers, including President Xi Jinping himself as the leader, have been envisioning having BRI Belt and Road Initiative as a vehicle or a mechanism

to broaden the use of Remembe along Belt and Road Initiative countries. And they even created sovereign funds to help broadening the use of Remembe. And that sovereign funds is called the Silk Road fund and it was launched around 2000. If I remember it correctly, it should be around 2014-2015-ish, if I remember it correctly. And at one of those Belt and Road Initiative International Corporation Forum, President Xi Jinping said, I'm going to give it another capital injection. And at this time, the capital injection is going to be denominated. Like the capital injection is going to be in Ramin B. The whole purpose is to broaden the use of Ramin B through this. initiative. And what is fascinating is once president made the announcement, the Chinese central

banker at that time came out and saying that this is a great idea and we are going to use the Silk Road Fund as a mechanism to facilitate the Riembe Internationalization Initiative. But the important part here is to remember is it's not really internationalization. It's not that they are removing capital controls or anything like that. They are doing this through creating a relatively regional space for Chinese importers, exporters, to make transactions, right? And in this particular context, it's also very important because Silk Road Fund, the creation of the Silk Road Fund was using China's foreign exchange reserves managed by state administration of a foreign exchange or safe, which is the foreign exchange reserve management arm of the People's Bank of China. And in order

to create the Silk Road Fund, the PBOC created a special entity called Buttonwood. And although capitalizing the Silk Road Fund was Buttonwood's initial mission, it then later went on to create additional investment funds played a very important role in stabilizing China's stock market. Yeah, I remember this. I think it came up in another one of our episodes, although I cannot remember which one. Since you brought up, Xi. Listening to you lay out why China wants this type of diversification, it makes a lot of sense.

And I think this is in many ways an underappreciated aspect of Xi Jinping and the CCP is that, like, they are good at identifying problems and vulnerabilities. It's just that sometimes they're bad at maybe identifying solutions. And sometimes I think Dan Wong, another one of our guests, pointed this. out in his annual letter, and I'm probably paraphrasing here, but like sometimes the solution is more painful than the problem itself. And you could make that argument for things like housing, what happened in the for-profit education space, the tech crackdown, all of those things. What is the mechanism or the scenario in which China's attempt to diversify away from the dollar ends up harming it in some way? Like, essentially, what are the risks here? I feel like

they need to be discussed. So let me take a step back by explaining what are the risk. What are the motivations for China to attempt to reduce exposure, right? In addition to economic reasons, there are what I consider as important geopolitical vulnerabilities that has direct financial security implication. And I describe it as the three eyes. I know that last time we talked about at the four days. Oh, yeah. And so any, Any great commenter has to have their thing. Our guest recently, Jason, comments from Brevin Howard, the three ends. So we like these.

All right, what are the three eyes? So the three eyes is under rising geopolitical tension, expose countries like China to liquidity challenge. It exposed countries like China to insecure challenge. And the other part would, because of insecurity, because, of illiquidity, China is building an alternative to insure against a lot of these vulnerabilities. So those are the three eyes. And the mechanism for China to achieve this is to create an alternative system. It can be summarized as a split. You have settlement and payment, that's the S and P. You have liquidity, which is L. And liquidity, the whole idea

of liquidity is to create international demand for the Raminbi and the Riembebe asset, right? And then I would be creating a sort of this international system to increase the insurance. And then the T part would be the trading, the whole idea of China being not just the world factory, but also a very important player in global commodities market. Now, the backfire scenario would be at the T scenario. Now you have all these plumbing system, you know, the settlement, the payment, a lot of these are the plumbing. Yes, you can make the argument to say that the transaction volume on the Chinese CIPS system is still very low, but the point is it's a proof of a concept. The idea is you buy insurance, you hope that you don't need it, but in case you need it, you have it ready to go, right?

And if the worst case scenario for China would be with the continued supply chain diversification, you started to say, okay, so what the implication for global currency system would be China started to build its own trading system, whereas denominated Yemeni, whereas the rest of the world is trading an entirely different currency. Now, what if in that scenario you have a currency war? And for central bankers' experience, foreign exchange reserves are one day in the central bank, but the next day could be gone. China lived through this around 2016 and 2017 within one year.

Foreign exchange reserves decreased from $4 trillion to $3 trillion. Right. So this experience is sort of very insecure from Chinese financier's perspective. Therefore, if the entire global trading system is split into two parts, to whom is China going to export in order to accumulate all the foreign exchange reserves that back China's Renminbi internationalization operation. I just have one more question about the current state of things in China.

We got a slew of data recently. Not great. Still a slump. But a second year in a row of declining population, I believe, more deaths than births. and a little bit worse than expected. This is another top demographics or another topic kind of like the dollar where just a lot of people have a lot of opinions and things to say. And I never really know how like serious.

What is, what do you think of as the economic implications or any implications of a shrinking population? First of all, I would say that currently perhaps we are living through a mood swing of the Chinese economy. because, you know, during the, around 2, 2022, before China officially exited the zero COVID policies, you know, a lot of people in the West were anticipating China's rapid snapback. And obviously the recovery of the economy has been disappointing. Therefore, we are now having this very much doomsayers mood. And demographics is one of the four days that we talked about. And I think in the short run, perhaps the challenge is even bigger than the long-term implication.

Now, the long-term implication is that, well, you know, the labor premium that China benefited from has shranked. Obviously, that's one argument that you can say. But, you know, China is also submitting a lot of money and investing in artificial intelligence, robotics and all that. And guess what? Japan is a good example. Instead of relaxing the immigration policy, they use robots. Right? So I do think the short-run implication is more severe because shrinking population, the reason why birth rate goes lower. Part of the reason is because, well, perhaps people are no longer getting married as often as basically the family formation rate, the marriage ratio declined. And it has a severe implication for the housing market because the demand for housing decrease. And housing remains constitute about 30%. 30% of China's GDP. And without housing market recovery, it is very difficult for the Chinese

economy to recover in the short run. I have just one more question, and it's not that important, but I'm going to ask it. Last time you were on the show, you gave us one of the greatest gifts in all-lots history, which is knowledge of the existence of idiot sunflower seeds, which has become one of my all-time favorite companies, like both for the business itself, but also for what it says about the development of the Chinese economy and what's happening now under Xi Jinping. Give me a new warm hole to go down in the Chinese currency market or the economy or rare earth metals, any of those. I'm up for it. Yeah. Something we can get obsessed with. This is a good question. This is a good question. I was trying to look through the Chinese economy

I'm trying to find like company icons that can respond to a different era. I have the idea of the watermelon seed that is one, sunflower seed. But I have been struggling to find another one. And since we were talking about energy transition and potential challenge to the dollar-based system, I'm going to see B-YD. It stands for... That's a good choice. It stands for Build Your Dream, right?

And if you look at how BiodiD, it stands for Build Your Dream, right? And if you look at how B.D, the rise of BID and to what extent it challenges a lot of foreign EV makers, it shows that perhaps the Chinese market is extremely competitive. And there are still reasons to be hopeful for the Chinese economy, especially for the high-tech sector. However, I would offer another cautious piece here, which is if you look at BID and who is the largest shareholders of its public. publicly listed shares, you will find Central Huijin owns more than 10% of these publicly listed shares. Yeah, it's funny you bring it up because Joe and I were actually talking about this earlier in the week. BYD shares have also fallen a lot. And it's this incredibly promising company that I think has overtaken Tesla to become, yeah, to become the biggest, like, maker of

electric vehicles. But investors are really down on its outlooks. I think in part because like the government has basically said this is a really important part of our economy and we want to be leaders in the EV market. And so there's a lot of pressure on them to invest, especially if one of their dominant shareholders is actually a public entity. You know, they're all sort of working together for the future development of the Chinese economy. So that means reinvestment, CAPEX. It doesn't necessarily mean dividends and share buybacks. Also, maybe the dollar system is under some sort of threat. But the English system, if the leader of your domestic manufacturing is build your dreams,

then I think the network effects of the English language are still extremely powerful. Very much so. Lots more is produced by Carmen Rodriguez and Dashel Bennett with help from Moses Ondom and Kale Brooks. Our sound engineer is Blake Maples. Sage Baumann is the head of Bloomberg Podcasts. Please rate, review, and subscribe to Odd Lots and Lots more on your favorite podcast platforms. And remember that Bloomberg subscribers can listen to all of our podcasts ad free by connecting through Apple Podcasts.

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