Chinese officials are studying the financial sanctions leveled by the U.S. and Europe against Russia as they hope to understand how the West might react to an invasion of Taiwan and how China might insulate itself from an economic conflict with the wealthy world, analysts and China watchers tell MarketWatch.
China’s refusal to condemn Russia’s invasion of Ukraine has not only been a source of strength for Russian President Vladimir Putin, it also reflects Beijing’s desire to weaken the U.S. grip on the global financial system as it attempts to turn its currency, the renminbi
into a credible alternative to the dollar for trade in Asia.
“Many in Beijing see recent events as a reason for dramatically accelerating efforts aimed at developing renminbi-based payments channels that are less vulnerable to U.S. sanctions,” Robert Greene, an expert of China financial-sector trends at the Carnegie Endowment of International Peace, told MarketWatch.
Greene said the short-term impacts of the sanctions, which ban several large Russian banks from transacting in dollars or euros and cuts off the Russian central bank from accessing dollar and euro-denominated reserves, are blunted by exemptions for Russia’s energy sector, but they send a unmistakable message to China that it too could be one day disconnected from U.S. and E.U.-led payment channels.
On Tuesday, President Joe Biden announced a U.S. ban on Russian oil imports. But U.S. allies, more dependent on Russian energy, are moving slower: the European Union this week will commit to phasing out its reliance on Russia for energy needs, while the U.K. announced Tuesday that oil and oil products from Russia will be phased out by the end of the year, the Associated Press reported.
Beijing has for years claimed that it wants a greater international role for the renminbi, but has been loathe to give up controls over the flow of capital to and from China and the value of the currency relative to the dollar, two steps that would be necessary to promote internationalization, according to Benn Steil, director of international economics at the Council on Foreign Relations.
Meanwhile, China’s economy has benefited from dollar
hegemony. Without the ability to build up large reserves of dollar-denominated assets like U.S. Treasury
debt, China would be unable to maintain its large export surplus with the world’s largest economy.
“If you imagine a world where there isn’t an international currency, the sort of global trade imbalances we see today almost certainly wouldn’t exist because countries wouldn’t want to accumulate other countries’ currencies,” Steil said. “The dollar as a dominant international currency does bring benefits to China and the rest of the world.”
That said, the sanctions against Russia could be a turning point in China’s attempts to increase the amount of trade with its Asian neighbors that is denominated in renminbi, Steil added. A major factor supporting the role of the dollar in international trade is that dollar liquidity makes it more profitable for banks to process dollar transactions, but cutting off an economy the size of Russia’s from the dollar system creates an incentive for some banks to eschew dollars in favor of other currencies.
“The sort of sanctions we are applying is like overprescribing a new effective antibiotic,” Steil said. “You see success in treating patients with the new antibiotic, so you prescribe it for everyone, but that causes the bacteria to mutate.”
Russia’s invasion of a sovereign neighbor that its leaders see as historically part of Russia has obvious parallels to China’s relationship with Taiwan. In an annual government report issued on Saturday, China said it was “committed to resolving the Taiwan question in the new era,” in what some analysts see as more urgent language than had been used in the past to describe the country’s ambitions.
Carl Weinberg, founder and chief economist at High Frequency Economics and a veteran China watcher, told MarketWatch that “Xi is using Putin as a test tube to see what’s in store for him if he decides to move on Taiwan.”
And while China may be surprised at the toughness of the sanctions against Russia and the resolve shown by the U.S. and Europe, the situation should be a wake up call for U.S. policymakers that a conflict over Taiwan could be devastating for the U.S. economy, Weinberg suggests.
“Other than its gas supplies to Europe, Russia doesn’t have economic leverage,” Weinberg said. “If China were to put an embargo on exports to the U.S., the whole American economy would grind to a halt.”
Neil Thomas, who studies Chinese politics and foreign policy for Eurasia Group, said in an interview on Eurasia’s media subsidiary, G-Zero, that the U.S. can take solace that “political signals do not indicate heightened aggression,” but that a Chinese attempt to take the island by force would garner a global response even more severe than what Russia has faced.
“Taiwan is more strategically important to the U.S. than Ukraine. It is part of a chain of islands that runs from Japan to Singapore and forms the bedrock of U.S. security and alliance guarantees in the Indo-Pacific,” he said. “It is also a far more important U.S. trade and investment partner and is home to semiconductor manufacturing facilities that form an essential link in many global supply chains.”
The future of dollar dominance
China has for years been working to build a parallel infrastructure that would enable Chinese financial institutions and those of its trade partners to transact in renminbi, including the creation of the Cross-Border Interbank Payments System, a platform to rival the Western-controlled SWIFT bank messaging system and the China National Advanced Payments system, which Russian banks like VTB participate in.
Central-bank digital currency could also play a role in the future of cross-border payments to and from China following research from the Bank for International Settlements showing that CBDC can reduce the time needed to make cross-border payments from days to just seconds and cut associated costs by about half. But just building out this infrastructure is not enough to unseat the dollar as the world’s dominant currency for international trade and reserves.
“Private investors are unlikely to place their trust in a reserve currency that is not backed up by a strong institutional framework,” wrote Eswar Prasad, senior professor of trade policy at Cornell University and former chief of the financial studies division at the International Monetary Fund in a Friday article in Barron’s. “Such frameworks — which encompass independent central banks, open and transparent governments, an institutionalized system of checks and balances, and the rule of law — remain the trump card of the U.S. and other Western nations.”
Economic historian Adam Tooze also provides a reminder in a Monday edition of his newsletter Chartbook that U.S. economic hegemony isn’t merely a residue of the post-World War Two order that is steadily weakening in proportion to China’s rise, but a result of policies that have benefitted the rest of the world. The Federal Reserve, in particular, has been a highly competent bureaucracy in times of crisis, most recently in its extraordinary response to the COVID epidemic.
“Hegemony isn’t a fixed, structural feature of the world. Hegemony is what you make of it,” he wrote. “You produce and reproduce it at moments of crisis by acting promptly and at scale. The Fed has acquired a well-justified reputation as a generous hegemon of the dollar-based global system.”