In the ongoing competition between China and the United States, a new front has emerged, centered around the US dollar. China is betting big on the fall of the US dollar, using its banks as key players in this effort. Chinese banks have been involved in a risky strategy known as “shorting” against the US dollar, pouring billions into these bets. If the dollar weakens, Chinese banks stand to profit. However, if the dollar strengthens, the consequences for these banks could be heavy losses.
Betting Against the US Dollar
Over the past year, Chinese banks have been betting that the US dollar will fall in value. This betting process involves a financial maneuver called “shorting.” To understand how it works, let’s break it down.
Imagine a small Chinese bank with 100 yuan. The bank decides to place a bet against the US dollar, so it lends its 100 yuan to an American bank and, in return, borrows the equivalent amount in US dollars. At the current exchange rate, 100 yuan is worth about 14 US dollars. Now, the Chinese bank holds 14 dollars, and the American bank holds 100 yuan. This exchange is a loan, and the two banks agree to settle the transaction after one year.
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In that one year, the value of the US dollar can either rise or fall. If the dollar weakens, the American bank will need to pay back more than 100 yuan to reclaim its 14 dollars, which means the Chinese bank will make a profit. But if the dollar strengthens, the Chinese bank could face losses, as it would end up receiving less value than it originally loaned.
This is essentially how shorting works. Chinese banks have engaged in numerous short positions against the US dollar through a financial tool called a foreign exchange swap. According to estimates, Chinese banks have made swap transactions worth more than 100 billion dollars. This means they are heavily invested in seeing the US dollar lose value. However, this strategy comes with risks.
The Reason Behind the Bets
Why is China taking this gamble? The reason lies in the Chinese economy and its currency, the yuan. The value of the yuan has been under pressure recently, losing value against the US dollar. In June, the yuan dropped to its lowest point in seven months. Two key factors are driving this trend: the strengthening of the US dollar and the weakening of China’s economy.
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China has seen investors pull billions of dollars out of its market, which has further weakened the yuan. Rather than addressing its economic problems directly, China is attempting a different approach. It is betting on the fall of the US dollar, hoping that by doing so, it can help the yuan recover.
When a bank takes a short position against the dollar, it swaps yuan for dollars. This reduces the amount of yuan in circulation, making the currency scarcer. And when something becomes scarcer, its value often rises. By reducing the supply of yuan through these swaps, China hopes to push up the value of its currency.
China’s central bank is the driving force behind this strategy, seeing it as a defensive move to stabilize the yuan. However, the risks are significant. If the US dollar continues to strengthen, Chinese banks could face substantial losses from these short positions.
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Billions Already Lost
China’s banks have already started feeling the negative effects of this strategy. Estimates suggest that they have lost between 5 and 16 billion dollars due to the dollar’s strength. Despite these losses, China is not backing down. Instead, it is assembling more resources to continue its challenge against the US dollar. China is now focusing its efforts on Wall Street.
Recently, Beijing ordered a merger between two large state-backed brokerages, creating a financial powerhouse valued at around 230 billion dollars. This merger is part of China’s broader plan to revamp its financial sector and compete directly with Wall Street. The Chinese government, led by its top leaders, has made it clear that it wants to build top-tier investment banks that can rival the largest financial institutions in the world.
Risk of Chinese Underground Banking
In the past, it was difficult to imagine such a split between the US and Chinese financial systems, given how closely their economies were linked. American companies invested heavily in China, and Chinese companies often listed their stocks on major US exchanges. At one point, more than 150 Chinese companies were listed in the US, with a total value exceeding 1 trillion dollars. But now, things are changing.
As the rivalry between the US and China deepens, the world is watching closely. China’s bold move to bet against the US dollar exposes its banks to massive risks, but it is a risk Beijing is willing to take in order to strengthen its currency and challenge the dominance of the US financial system.
