Bracing for yuan payments pretty soon

China one day will demand paying in yuan for imports from Korea.

Kim Young-ik

The author is a professor of economics at Sogang University Graduate School of Business. The mightiness of the U.S. economy and the dollar is diminishing. The trend will likely continue for the next five years. The United States has been fueling global economic growth as the largest consumer. Since China joined the World Trade Organization in 2001, the balanced role of the U.S. as a major consumer and China as a key manufacturer has been the linchpin in the growth of the global economy. From 2001 to 2022, China has accumulated a surplus of $6.2 trillion in trade with the U.S. thanks to its cheap labor.

With some of the U.S. dollars from its trade with the U.S., China bought U.S. Treasuries. China’s holdings of treasury notes ballooned from $78.6 billion at the end of 2001 to $1.27 trillion by the end of 2013. After slowly unloading some of them since, the amount dwindled to $848.8 billion as of February.

After joining the WTO, China showed high growth rates primarily thanks to exports. The economy grew 8.4 percent a year on average from 2001 to 2022, more than twice as fast as the global average growth of 3.5 percent. During the same period, the U.S. economy annually grew at an average of 1.9 percent. According to the International Monetary Fund (IMF), the share of China’s GDP in the global economy jumped to 18.1 percent in 2022 from 3.9 percent in 2001. During the same period, the share of the U.S. declined to 25.4 percent from 31.3 percent. China’s ascension owed largely to the shriveling of the Japan’s share to 4.2 percent from 12.9 percent during the same period.

China’s purchase of U.S. Treasuries has contributed to stabilizing U.S. interest rates and feeding financial market growth in America. U.S. stock market capitalization surged from $16.45 trillion at the end of 2001 to $80.6 trillion at the end of 2021, although it fell to $64.5 trillion at the end of 2022. During the same period, the market cap-to-nominal GDP ratio also surged to a historic high of 329 percent from 154 percent.

But while the U.S. was leading global consumption over the last two decades, its internal and external imbalances have worsened. Domestically, private and government debt shot up to 415 percent against GDP by the second quarter of 2020 from 304 percent in 2001. Although eased to 358 percent in 2022, the debt share remains extremely overwhelming. The federal government debt against GDP more than doubled to 131.8 percent by 2020 (123.4 percent in 2022) from 54.5 percent in 2001. On top of that, the bubbles from the extraordinarily loose monetary policy to fight the global financial crisis in 2008 and the pandemic-induced recession in 2022 are bursting across all assets.

The external imbalance is also deepening due to the surges in government expenditures and imports. The U.S. current account deficit swelled to $11.86 trillion from 2001 to 2022. Foreign direct investment and stock investment mitigated some of the losses. But during the same period, the U.S. net external debt — its gross external assets minus its gross external debt — surged from $2.29 trillion in 2001 to $16.12 trillion in 2022. The net debt-to-GDP ratio also snowballed to 63.3 percent in 2022 from 21.7 percent in 2021 after hitting a historic high of 77.7 percent in 2021.

The U.S. dollar has lost much of its luster in the process of easing domestic and external imbalances. The dollar index against a basket of major currencies slipped to 76.1 in 2011 from 115.5 in 2000. The index rose to 92.8 in 2021 as the share of the U.S. in the global economy and the value of the dollar recovered. The average dollar index in 2022, which hit 104.0 — the highest since 2002 — owed much to the rapid gains in the federal funds rate last year. The Federal Reserve yanked up the rate range from 0.00-0.25 percent in February 2022 to 5.00-5.25 percent by May this year. Money chases higher yields. Capital flock to the U.S. offering high returns has bolstered the greenback value. The global uncertainties from Russia’s invasion of Ukraine also upped the demand for safe assets like the U.S. dollar.

However, the dollar index that climbed as high as 114 last September fell more than 10 percent to hover around 101. The foreign exchange market is betting that U.S. rates will fall on a receding economy that no longer can endure interest rates running above 5 percent. The U.S. economy is expected to suffer a mild recession this year from depressed consumer spending.

Private consumption, which makes up 71 percent of the U.S. GDP, is sinking due to four factors. First, real disposable personal income has been stagnating as the rise in wages cannot keep up with the inflationary run. Second, the household saving rate fell to 3.7 percent last year, the lowest since 3.4 percent in 2007 prior to the global financial crisis. As savings have been wasted, Americans have less to spend in the future. Third, the depreciation of stock and housing prices have pared the wealth of American individuals. Fourth, the effect from rate hikes will spill over the economy after a time lag from monetary actions.

In the mid-to-long term, there are more factors pointing to the downside of the greenback than otherwise.

First, the role of the U.S. would become smaller as it is forced to tend to domestic and external imbalances. The IMF expects the share of the U.S. in global GDP to fall to 24.0 percent in 2028 from 25.4 percent in 2022. The share of China is expected to increase to 20.4 percent from 18.1 percent in the same period. The reduced U.S. weight will translate into a fall in the dollar value. Second, capital inflow to the U.S. is likely to slow as the U.S. role as the world’s prime consumer and China’s role as the major manufacturer weaken. Foreigners’ share in U.S. government bond holdings was 17.5 percent in 2001 and 34.0 percent in 2014, but slipped to 23.3 percent in 2022, as Chinese and other exporters divested the U.S. notes. China is expected to continue selling U.S. Treasuries.

Third, the dollar share in FX reserves at global central banks was 71.1 percent in 2000, but it fell to 58.4 percent last year, according to the IMF. Russia and China have been dumping U.S. treasuries and instead bumping up gold purchases. Gold possession at the Russian central bank surged to 2,299 tons in 2022 from 343 tons in 2000. China’s gold holding piled up to 2,011 tons from 395 tons during the same period, but the share at the Chinese central bank’s FX reserve still remains low at 3.5 percent. The gold share in Germany’s FX reserve hovered at 66.5 percent in 2022. Italy and France are also gold-rich with shares in FX reserves at 63.6 percent and 58.6 percent, respectively, in 2022.

Fourth, the paradigm shift in global currency order also bodes badly for the dollar. The U.S. has resorted to dollar weaponization to punish Russia for its invasion of Ukraine. The U.S. has cut off Russia from SWIFT — the primary financial messaging service used to execute international transactions among banks — after North Korea and Iran. The U.S. also froze Russia’s dollar-dominated FX holdings. Those isolated countries have grouped with China to find an alternative payment solution. Russia is using the Chinese yuan to settle its trade with China. China is working to pay for raw materials and crude oil supplies from Brazil and Saudi Arabia in its own currency instead of the U.S. dollar.

Given the accumulated imbalances in the U.S. and the changes in the global economic order, the U.S. dollar’s role as reserve currency and its value will likely weaken in the longer run. Korea’s economic players must brace for the seismic change.

The government must try its best to keep balance in external policy. It must ready against the reduced U.S. and Japanese share in the global economy. In last year’s exports, China took up 22.8 percent of Korea’s outbound shipments and Asean 18.3 percent, larger than 16.1 percent for the U.S. and 4.7 percent for Japan. That’s the trend of the global economy.

The Bank of Korea also must consider upping the share of gold in its FX reserve. The latest trend of the dollar’s weakening and strengthening in gold price could be entrenched. Companies must diversify export markets and prepare for the currency change in international trade.

China one day will demand paying in yuan for imports from Korea. Individuals also need to consider lessening the share of their U.S. assets. During the dollar weakening period, Korean stocks rose higher than U.S. stocks. The National Pension Service and other institutional players also must turn to non-U.S. markets in their asset management to reap greater returns.

Translation by the Korea JoongAng Daily staff.