Western sanctions imposed on Russia in response to its invasion of Ukraine look set to accelerate the economic decoupling under way between the United States and China, especially if Beijing seizes the opportunity to enhance the global appeal of its currency and financial architecture.
By blocking Moscow’s access to nearly half of its $630 billion in foreign-exchange and gold reserves, Washington has offered a demonstration of how much raw financial power still remains in the hands of the West. That can only strengthen China’s determination to stick to its own ideological path and carve out a sphere of geopolitical influence.
The United States and other major Western countries have also barred most Russian lenders from the SWIFT global interbank messaging network and from access to U.S. correspondent banks, a critical enabler of worldwide payments.
Such punishments are likely to hasten the bifurcation of the global economic and financial system—a process my firm, Enodo Economics, dubbed the “great decoupling” a few years ago. Financial self-reliance will be an important feature of the emerging new order.
China is not alone in failing to condemn Russia for its invasion and in expressing concern over the sanctions. Any country uneasy of the West’s ruthless display of state financial power may well choose to hedge its dependence on the dollar by taking a stake in Russian and Chinese alternatives.
Russia has relied on the BRICS group (consisting of Brazil, Russia, India, China, and South Africa) of emerging economies to extend the use of national currencies in trade and integrate their payment systems. Such steps were necessary because Western sanctions have destroyed the foundation of the existing international monetary and financial system based on the dollar, said Russian Finance Minister Anton Siluanov.
Russia has set up its own banking messaging system, known as SPFS, as an alternative to SWIFT. Its own card payment system, Mir, began operating in 2015. But Russia’s share of the global economy is tiny. If countries don’t want to throw in their financial and economic lot with the West and stick with the dollar, they have only one realistic alternative: China and the yuan, also known as the renminbi. Saudi Arabia, disenchanted with the United States, is already looking at getting paid in yuan for the oil it sells to Beijing after trading crude exclusively in dollars for nearly 50 years.
Predictions of the dollar’s dethronement as the preeminent reserve currency are as old as the hills. But if China can make its financial and cross-border payment systems more appealing and if the renminbi grows in stature, the greenback’s hegemony could be undermined over time.
But China has to tread carefully. It must make sure that its banks, if they increase credit lines to Russia as a favor to Russian President Vladimir Putin, do not fall foul of Western sanctions.
Given that about 75 percent of China’s goods trade is still invoiced in dollars, being barred from the dollar-clearing system and SWIFT would have unfathomable consequences for both Chinese banks and the global economy.
One likely course of action is for China to speed up the development and global use of its own Cross-Border Interbank Payment System (CIPS) for transactions in renminbi.
The People’s Bank of China launched CIPS in 2015 to reduce the country’s need to work in dollars through U.S. banks. As of the end of March, CIPS had 76 direct members. Most of those are onshore correspondent banks, but about 25 members are offshore clearing banks. CIPS also has its own messaging system, but for now, it relies on SWIFT.
Although CIPS is tiny compared to both SWIFT and CHIPS—Clearing House Interbank Payments System, the U.S. dollar settlement and clearing platform—it is likely to receive a boost due to Western sanctions on Russia.
On the face of it, the global payments system could do with a competitive shake-up. Unlike domestic electronic payments—which have become increasingly secure, speedy, and convenient—cross-border payments can take days to settle and can cost up to 10 times more.
Alongside CIPS, China’s fledgling digital currency, the e-CNY, also has an important role to play in enhancing the international attractiveness of the renminbi. The e-CNY, which was on show during the recent Winter Olympics in Beijing, is likely to make cross-border payments cheaper and more efficient than they are now.
China’s maintenance of capital controls is one of the main obstacles to the yuan becoming a rival to the dollar. But that could change if a cross-border digital currency system structured around the yuan and operating on standards set by Beijing came to be used in China’s putative sphere of influence. In that case, the People’s Bank of China would have such clear visibility and control over payment flows that China would probably consider making the yuan fully convertible.
China set about internationalizing the yuan in response to the shock of the 2008 global financial crisis. The yuan’s use in cross-border trade increased, central banks started holding it in their reserves, and it was added to the basket of currencies that make up the International Monetary Fund’s reserve asset: the special drawing right.
Yuan internationalization initially seemed to be working—albeit very slowly. However, the process peaked in 2015 when the People’s Bank of China bungled a change in the mechanism for setting the renminbi to U.S. dollar’s daily central parity and a nearly 3 percent decline in two days caused the market to scream devaluation. So as the yuan declined and renminbi internationalization began to reverse, it became clear that success up to that point had been driven by foreigners’ willingness to hold an appreciating currency.
China was forced to reassess. Beijing needed to give foreigners a better reason to hold onto the yuan rather than simply counting on the currency to keep appreciating. In 2018, China set about strengthening its domestic capital markets and opening them up to offshore investors.
Galvanized by the West’s sanctions on Russia, Beijing can now be expected to accelerate its efforts to boost the use of the yuan in international markets.
In the short term, the task will not be easy. Putin’s adventurism has triggered a crisis that China could do without as it battles to keep the economy stable amid surging omicron cases, massive lockdowns, and sharp downward growth following Chinese President Xi Jinping’s assault on the tech and property sectors.
And in the longer term, the United States has ample scope to counter China by building a resilient sphere of influence that stays true to the values of free, liberal markets.
How this battle for supremacy evolves and how the global financial system bifurcates will depend in part on how well the United States and China cope with what is likely to be a prolonged period of stagflation. Keeping inflation low and growth strong greatly burnishes the appeal of a country’s currency and financial assets.
The reordering of global supply chains as a result of the great decoupling between the world’s two biggest economies is a powerful factor behind the current flare-up in inflation.
Reorganizing supply lines and reshoring manufacturing is a costly process that will take years. The upshot is that cost-push inflation will be protracted. This is not a passing phase.
Much like the pandemic, the invasion of Ukraine will deepen the global rift between U.S.-led, rules-based economies and their authoritarian adversaries, entrenching inflationary pressures.
However the war in Ukraine pans out, the global economy thus faces a huge adjustment. Whoever succeeds in turning the problem of stagflation into an opportunity to boost innovation and domestic productivity as well as succeeds in building a robust sphere of influence will emerge the winner.