Russia can rely on China for the yuan, but China can’t rely on anyone else

• Western sanctions have forced Russia to rely on the Chinese yuan for reserves and trade.
• China is concerned about sanctions, too. But unlike Russia, it lacks alternatives to the dollar.
• China’s financial system is deeply tied to the greenback, limiting diversification options.

Sweeping Western sanctions against Russia have isolated its economy so much that it now relies on the Chinese yuan for its reserves.

Russia’s isolation has also worried China — whose $18 trillion economy far outsizes Russia’s $2 trillion — about relying on the US dollar-based financial system, prompting calls in the country to reduce the exposure of its financial system against the greenback.

However, unlike Russia, Beijing has far fewer alternatives, wrote Robert Greene, a non-resident scholar at the Carnegie Endowment Asia Program and Cyber Policy Initiative.

“Russian authorities diversified the country’s foreign exchange reserves in large part by buying renminbi assets, but a similar option is not possible for Chinese authorities,” wrote Greene on Thursday.

There are many reasons for China’s de-dollarization limits.

These include the entrenched role of the greenback in the global commodities trade and much larger foreign reserves than Russia, wrote Greene, a former senior advisor at the US Treasury. He is also a vice president at consultancy Patomak Global Partners.

China keeps circling back to the dollar

To be sure, China has been trying to reduce its reliance on the dollar. Notably, it set up the yuan-based Cross-Border Interbank Payment System, CIPS, to process transactions. However, many CIPS participants are highly connected to the dollar financial system and potentially subject to the reach of US sanctions.

Meanwhile, about half of China’s foreign reserves are held in the dollar. The country’s dollar assets in 2023 were over 15 times the value of Russia’s in 2019, wrote Greene. Russia’s central bank reduced dollar-denominated foreign reserve assets significantly from 2020 in the leadup to its invasion of Ukraine, which means China’s dollar reserves could be far higher than Russia’s by this point.

“China could also, in theory, modestly diversify some reserves away from the dollar into government debt securities denominated in currencies of relatively small and open economies,” wrote Greene.

However, non-major currency assets — outside the realm of dollar, euro, and yen — “may not present meaningfully less geopolitical risk than the dollar.”

Other than foreign exchange reserves, China’s largest state-owned financial institutes, including its four major state-owned commercial banks, are deeply interconnected to the US financial system.

“These institutions often rely on dollar funding to finance overseas activities, and in recent years at times maintained dollar-denominated liabilities worth significantly more than dollar-denominated assets,” Greene wrote, citing a research paper published by the Federal Reserve Bank of Boston in 2022.

China’s ties to the dollar manifest in other ways.

Most of China’s Belt and Road Initiative loans have been denominated in the dollar. Many Chinese companies have tapped US dollar equity financing.

China also actively manages its exchange rate relative to the dollar, added Greene.

The dollar is still king

In short, China just can’t copy Russia’s sanctions-proofing playbook and is likely to continue orbiting around the dollar financial system in the near-term.

It’s not just China that’s finding it to break up with king dollar.

Talk about de-dollarization has come back in waves every few years since at least the 1970s.

But the dollar still reigns, thanks to its position as a haven asset.

As James Lord, Morgan Stanley’s head of FX strategy for emerging markets, asked on a May podcast; “Which currency would you want to own when global stock markets start to fall, and the global economy tends to head into recession? You want to be positioning in US dollars because that has historically been the exchange rate reaction to those kinds of events.”

“Bottom line, king dollar doesn’t really have any challengers,” Michael Zezas, the firm’s head of US public policy research, added.