Zongyuan Zoe Liu
Chinese policymakers are increasingly convinced that the United States is determined to implement a full-fledged strategy of containment against China. Beijing views the Indo-Pacific Economic Framework for Prosperity as the economic mirror of the Quadrilateral Security Dialogue and AUKUS, two U.S.-led security pacts that Beijing regards as anti-China coalitions. Chinese officials, academics, and media rhetoric increasingly talk of self-reliance and are preparing for a forced decoupling from the United States. Fang Xinghai, a vice chairman of the China Securities Regulatory Commission, proposed accelerating the yuan’s internationalization to prepare for the risk of forced financial decoupling. A Shanghai-based academic argued that “the peace dividend is over”—hence, “it is time that China prepare for a full decoupling.” Even the more moderate voices have acknowledged the profound changes in U.S.-China relations behind the “decoupling theory” and called for China to “prepare for the worst but strive for the best.”
While part of the likely response will be the further strengthening of China’s military, the party-state will also tighten two economic strings in its bow. It will double down on pursuing a preexisting self-reliance strategy and sanction-proof the Chinese economy while bolstering its offensive geoeconomic capabilities by reinforcing China’s strategic position in global supply chains and expanding its influence in international commercial sea lanes.
The Chinese Communist Party (CCP) made “independence and self-reliance” the centerpiece of its 2021 historic resolution. The West’s recent harsh sanctions on Russia have reminded Chinese leaders of the need to strengthen economic autonomy. On Feb. 25, the day after Russia’s invasion of Ukraine, a People’s Daily editorial argued that “independence and self-reliance ensure that the cause of the party and the people will continue to move from victory to victory.” The government recently vowed to improve self-reliance by building a “national unified market.” Policymakers are looking to prepare the Chinese economy to withstand the heavy economic blow caused by a forced decoupling.
These concerns are not new. Chinese policymakers have been advocating reforming the global financial system since immediately after the Asian financial crisis at the end of the 1990s, seeking to hedge against U.S. dollar hegemony. In 1999, Dai Xianglong, then-governor of the People’s Bank of China (PBOC), argued that the existing global financial system “needs to be reformed” because “the role of international reserve currency played by a few countries’ national currency has been a major source of instability.”
One major component of China’s defensive strategy against perceived Western containment is building a yuan-based global commodities trading system, in an effort to improve the yuan’s pricing power, reduce China’s vulnerability in the global resources trade, and strengthen China’s global financial position. Major Chinese oil suppliers, such as Russia, Angola, Venezuela, Iran, and Nigeria, now accept yuan in their oil trade with China. The Shanghai International Energy Exchange launched the yuan-based Shanghai crude oil futures in 2018, and in April 2021, the total trade volume of the yuan-valued oil futures reached 44 trillion yuan ($6.7 trillion), with clients from 23 countries and regions. Oil exporters could convert their yuan oil revenue into gold on the Shanghai and Hong Kong gold exchanges. This interconvertibility implies that China, the world’s largest oil importer, has a complete domestic infrastructure for indirectly trading oil using gold. This marks the beginning of pricing alternatives for a major global commodity.
China could capitalize on the current energy transition to cultivate a “gas-yuan,” emulating the petrodollar. Just as oil-producing countries depend on dollar revenues that aren’t freely spendable elsewhere, gas-producing ones such as Russia and Iran could be dependent on the yuan. In China’s 2017 World Energy Development Report, Chinese scholars proposed the concept of gas-yuan. Given the fragmented nature of global natural gas markets and China’s leverage as a leading buyer, the emergence of a gas-yuan is not a pipe dream.
Russia, Iran, and China collectively produce more liquefied natural gas (LNG) than the United States, and they all have non-dollar financial infrastructure in place. China has become the world’s largest LNG importer. Iran, which shares the world’s biggest gas field with Qatar, is reviving its previously sanction-stalled LNG export plan as the European Union attempts to cut its dependence on Russian gas as a punishment for President Vladimir Putin’s invasion of Ukraine. Although China has not provided material support to Russia or bluntly helped Russia dodge Western sanctions, China’s LNG imports from Russia doubled in February. The collective revisionist geoeconomic power of China, Russia, and Iran arguably is much stronger than that of the OPEC.
Higher global demand for natural gas as a transition fuel in the move toward net-zero emissions and the decoupling of gas prices from oil prices also provide a benign macro condition for the emergence of a gas-yuan. However, it would not be easy for the yuan to quickly achieve the status of a dominant currency and pose a credible threat to the dollar hegemony. The lack of attractive yuan-denominated assets and the lack of desirable high-value goods and services exported from China preclude the rise of a petroyuan—or gas-yuan—anytime soon. China’s addiction to current account surplus and relatively closed capital account also prevent Chinese government bonds from rivaling U.S. Treasurys.
Another component of a China-initiated financial system is the PBOC’s Cross-Border Interbank Payment System (CIPS), augmented by the digital yuan. Launched in 2015, CIPS has become a proprietary financial infrastructure that could allow sanctioned entities to plumb into global markets, though dodging sanctions was not the original motivation for its introduction. Initially developed to promote yuan internationalization, the Shanghai-based CIPS is increasingly seen as China’s alternative to the SWIFT global banking system even before some Russian banks were kicked off.
CIPS combines financial messaging services and settlement functions in one platform. It is China’s alternative to the “SWIFT + CHIPS” combination that moves the dollar across different institutions globally. Sending financial messages using CIPS and completing settlements onshore can eliminate the risk of exposing transaction information to the United States, which could theoretically cut sanction-triggering information flows. Moreover, using the yuan for settlement removes the dollar from transactions, excluding the need for CHIPS. As it stands now, CIPS is limited in capacity and international coverage. According to the CIPS website, CIPS currently has 76 direct participants—64 of which are in Asia, eight in Europe, and only one in North America. Moreover, it still relies on interoperability and integration with SWIFT to encourage broader participation.
The PBOC has cooperated with SWIFT to get localized services, which in theory could mitigate the impact of sanctions. It launched a 10 million euro ($12 million) joint venture named Finance Gateway Information Services (FGIS) with SWIFT in January 2021, shortly before the United States, EU, U.K., and Canada sanctioned several Chinese officials for human rights abuses against Uyghurs. FGIS will build a local network for financial messaging services and establish a localized data warehouse to store, monitor, and analyze cross-border payment messaging information. Notably, CIPS and the PBOC’s Digital Currency Research Institute are FGIS shareholders. Their presence suggests that FGIS is empowered to promote the use of digital yuan in cross-border transactions. Once materialized, this could be another damage control mechanism if major Chinese banks were de-SWIFTed.
These measures are effectively defensive, looking to isolate China from the consequences of a U.S. containment strategy. But in a worst-case scenario of a financial war triggered by an extreme event, such as a military clash over Taiwan, Beijing could deploy two offensive retaliatory measures: disrupting global supply chains and restricting foreign access to Beijing-controlled commercial ports. Deliberate supply chain disruptions could come in at least two forms: enforcing the anti-sanctions regulatory framework to restrict access to the Chinese market and imposing export controls on critical materials.
China has passed five major pieces of legislation aimed at blocking the impact of U.S. sanctions since 2018: the International Criminal Judicial Assistance Law, the Provisions of the Unreliable Entity List, the Extraterritorial Rules, the Anti-Foreign Sanctions Law, and the Export Control Law (ECL), the first Chinese law that establishes a comprehensive and integrated export control regulatory regime, as well as the State Council’s white paper on China’s export control.
As the enforcement of these statutes is fleshed out, the Chinese government could force foreign companies to choose either the Chinese market or the Western market and deter and penalize cooperation with foreign actions viewed as threatening to Chinese business and national interests. In particular, the ECL and the white paper show that Chinese policymakers have a clear vision of how to strategically leverage China’s dominance in global supply chains to retaliate against foreign restraints and protect China’s national interests. The ECL, for instance, has a reciprocal measures provision, which states that China may take reciprocal measures against any country or region that abuses export control and hurts China’s national security and interests as assessed by Chinese government agencies. These measures are not without costs for Chinese companies. Rising regulatory and geopolitical uncertainties may unintentionally cause a slowdown in China’s inbound investment while also forcing Chinese companies to look for the “X” in the “China + X” supply chain management model for fear of disruptions.
The export control framework may give the Chinese government a new opening to restrict rare-earth exports under a national security exception to World Trade Organization rules against restraints on free trade. The ECL could provide a legal foundation for China to use national security concerns to restrict exports of rare earths crucial for manufacturing high-tech consumer electronics and sophisticated U.S. weapons, including F-35 fighter jets, to the United States and its allies to retaliate against Western containment. China supplied 80 percent of U.S. rare-earth imports between 2014 and 2017. Beijing was reportedly exploring such an option in 2019 and 2021 amid an emerging Sino-American technology war. This reported threat of retaliation against the United States mirrors China’s rare-earth exports ban against Japan in 2010 following the Japanese government’s detention of a Chinese fishing boat captain. Of course, leaning too heavily on such coercive threats can be counterproductive. China doesn’t enjoy a monopoly over rare earths themselves—which are not, in fact, particularly rare—but over the processing chain of rare earths thanks to costs and environmental concerns. If the United States becomes too worried about the threats suggested by Beijing, it has the capacity to set up its own alternative processing chain well in advance of a crisis.
China’s emergence as a leading commercial maritime power provides another source of leverage for Beijing in times of an economic war. Chinese port acquisitions grant China greater control over global shipping flows that could restrict foreigners’ ability to secure supply chains. By 2019, China had invested in 101 port projects globally. Three Chinese port operators—COSCO Shipping Ports, China Merchants Port Holdings, and Qingdao Port International Development—already held stakes in 16 European ports, as of 2018. COSCO owns 100 percent of Piraeus Container Terminal in Greece, 85.5 percent of CSP Zeebrugge Terminal in Belgium, 51 percent of Noatum Container Terminal in Spain, and minority shares in several other European ports.
All of these strategies, as noted, come with their own risks. While the Biden administration should seek to challenge and coexist with China by the “invest, align, compete” strategy, it should also resist the temptation of either overestimating China’s capacity and demonizing Beijing or naively dismissing China’s potential to challenge U.S. global leadership and the dollar’s dominance. Washington can marginalize China’s attempt to neutralize U.S. geoeconomic power by strengthening the attractiveness of U.S. leadership and the appeal of the existing global system. It is time for the United States to lend a sympathetic ear to countries that have longed for development support or demanded representation in the existing global system before they hear China’s appeals instead.
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