Economic sanctions have long been a tool of statecraft as countries jostling for power employ coercive methods to impose their will on others. Under President Donald Trump, the United States has been exploiting its dominance in the global financial system to implement economic sanctions to a degree never seen before. The weaponization of financial networks by the U.S., predicated on the greenback’s unrivaled status in international finance, is resulting in blowback. Unintended consequences are forcing nations to contemplate an appropriate response – fight back, prevent the U.S. from enacting further sanctions, and reduce vulnerability to America’s financial system. From China’s point of view, America’s financial dominance poses two daunting challenges: 1) coercive interdependence that entangles and constraints China, which in the event of decoupling would impose massive costs on both nations; and 2) financial asymmetry, where the Trump administration has taken advantage of critical nodes and chokepoints in the global financial architecture to compel policy change in others. For Beijing, coercive interdependence and financial asymmetry pose vexing security issues with no easy answers or quick fixes.
Last year, the People’s Bank of China (PBOC) announced its program for digitizing the renminbi (RMB), launched with the aim of introducing the world’s first digital currency. Although the immediate goal is to counter Facebook’s Libra and other cryptocurrencies that are seen as a destabilizing force and encroaching on monetary authority, the longer-term objective is for China to gradually wean itself away from the dollar. Why? America’s unilateralist approach to financial sanctions has angered friends and foes alike. Weaponizing financial networks feeds a growing chorus of voices in Beijing that calls for reducing exposure to America’s authority over key control points in global finance, establishing alternative channels for international payments, and expanding the use of the renminbi in cross-border transactions.
Last year witnessed several key events that confirmed for China’s policymakers that a move away from the dollar is a national priority. The first was Washington’s labeling of China as a currency manipulator. The move demonstrated America’s long-arm of the law, which extends to virtually any jurisdiction or entity that relies on the USD and dollar clearing, and consequently encouraged the increased use of the renminbi in international transactions. Second, Facebook’s Libra was seen as a disruptive force, eroding a Central Bank’s ability to exercise sovereign monetary authority in setting interest rates and protecting the currency. Third, the arrest of Huawei’s CFO Meng Wanzhou and subsequent targeting of the firm landed dozens of Huawei’s affiliates on a U.S. Commerce Department Entity List, effectively shutting the company out of critical high-tech components. The tacit understanding here is that if Huawei builds out the majority of the world’s 5G telecommunications backbone, China will do to the U.S. in the technological sphere what the U.S. has long been doing to the rest of the world in the financial arena. The targeting of Huawei came on the heels of America’s tussle with ZTE, a rival Chinese phone maker, who was banned from buying U.S. components, in effect paralyzing the company. Only after Trump personally intervened and ZTE agreed to pay a fine was the firm spared from collapse.
As a result, China learned some tough yet valuable lessons from these episodes: exposure to the dollar makes it vulnerable, and the United States is no longer an objective and reliable partner. And while the immediate focus in the aftermath of the Huawei and ZTE cases was on the complex web of interconnected supply chains, the greater underlying significance for China is its overreliance on the USD and dollar-based payment networks.
What options does China have? First, the introduction of the Digital Currency Electronic Payment (DCEP) – a digital renminbi – is a foundational step in eventually loosening the dollar’s vice grip. Currently, the People’s Bank of China (PBOC) is making considerable headway in digitizing its current monetary base (it is not a new currency) and is ahead of peers in Europe and America. Moreover, a digital RMB allows Beijing to forge closer economic and security ties with countries participating in its mammoth Belt and Road Initiative.
However, America’s financial hegemony is not merely limited to the dollar, but also to the twin pillars that underpin the global financial architecture – the dollar clearing system and SWIFT. The second course of action is the promotion of the PBOC’s Cross-border Interbank Payment System (CIPS) denominated in yuan, which today counts on 1,000 member banks. Whereas CIPS saw $3.8 trillion USD equivalent in total payments for all of 2018, the SWIFT payment system on average processes about $6 trillion USD in daily transactions. CIPS barely makes a dent. As America continues to abuse its stewardship of financial networks, other countries, including European allies, are seeking alternative payment mechanisms. CIPS plays an important role in signing up entities from Russia, Turkey, and others that have been subject to America’s sanctions, as well as nations taking part in the Belt and Road Initiative (BRI). America’s antagonistic attitude has turbocharged plans for expanding CIPS.
But getting countries and non-state actors to sign on to CIPS is a lengthy process. The real barrier to widespread international adoption of the renminbi and China’s alternative clearing mechanisms may be the strict currency controls that remain in place, show no sign of any meaningful abating, and which Beijing ultimately controls. For its part, the Trump administration continuously fails to recognize that emerging powers want a larger voice at the table of world affairs. China’s craving for greater participation in existing international regimes as well as establishing competing (yet somewhat complementary) programs – whether it’s CIPS, BRI (Belt and Road Initiative), BRICS Bank (New Development Bank), AIIB (Asian Infrastructure Investment Bank) – is only natural and to be expected. Regrettably, weaponizing financial networks has become a new flashpoint in China-U.S. relations. We can expect to see more headlines in this new theater of battle.