MNI INTERVIEW: Oil Shock To Squeeze Dollar Liquidity In Asia

A sustained energy shock will weaken the dollar's pricing function for oil and squeeze dollar liquidity, a leading Chinese economist told MNI, adding that Asian countries should diversify foreign reserves and add more yuan in a shift to a new regional monetary arrangement.

Petrodollars are a major source of global dollar liquidity, and a shortfall would push up the dollar's exchange rate and interest rates, raising financial risks in Asian nations which rely heavily on a stable supply of U.S. currency, former Bank of China chief economist Cao Yuanzheng, one of the designers of China’s roadmap for yuan internationalisation, told MNI.

At the same time, increasing economic integration within Asia means there is an urgent need for a regional financial order, Cao said, calling for countries to deepen the Chiang Mai Initiative currency swap, and to expand its scope from ASEAN+3 to the Regional Comprehensive Economic Partnership. (See MNI INTERVIEW: Mid-East Conflict Is Chance To Promote Yuan Use)

CMI is a regional financial arrangement established by the ten ASEAN members plus China, Japan, and South Korea to provide liquidity support. The framework includes a reserve pool of USD240 billion, with China, Japan, and South Korea collectively contributing 80% and ASEAN countries contributing 20%, which can provide short-term dollar liquidity support to address crises, typically in conjunction with an IMF program.

Cao called for replacing part of the dollars in the CMI reserve with yuan in a bid to reduce the dependence on dollar in the region.

The yuan already accounts for 30% of China's foreign trade settlement, with the proportion even higher in the oil trade, reducing the importance of the dollar, Cao said, adding that the main effect of fluctuations in the U.S. currency on the economy now comes via holdings of dollar assets. Some currencies, including many in Asia, the Australian dollar and the Russian rouble, are beginning to show signs of correlation with the yuan, he said.

PROLONGED CONFLICT

The Middle East conflict has other worrying implications for global supply chains, with interruptions to fertiliser production likely to push up food prices and a lack of chemicals needed for plastic manufacture already causing shortages of plastic bags in Taiwan, he noted.

While China, as a major producer of urea, is able to meet its own fertiliser needs, it may prioritise its own domestic agricultural demand, he said. (See MNI: Energy Price Jump To Restrain, Not End PBOC Easing Bias)