US sanctions boost China’s cross-border currency use

Diplomat author Mercy Kuo regularly engages subject matter experts, policy practitioners, and strategic thinkers around the world for their diverse insights into U.S. Asia policy. This conversation with Dr. Daniel McDowell – Maxwell Advisory Board Professor of International Affairs at the Maxwell School of Citizenship and Public Affairs at Syracuse University, senior fellow of the Atlantic Council, and author of ‘Bucking the Buck: US Financial Sanctions and the International Backlash Against the Dollar ” (Oxford University Press 2023) – is the 434th in “The Trans-Pacific View Insight Series.”

Explain how US sanctions against Russia encouraged the cross-border use of the Chinese currency, the renminbi (RMB).

Two ways. First, by increasing the use of the RMB in cross-border trade arrangements directly between China and Russia. U.S. financial sanctions prevent certain actors from using the dollar system, forcing targets into alternative currencies exchanged outside the U.S. financial system. Beijing and Moscow were already de-dollarizing their bilateral trade prior to the war in Ukraine, after years of escalating US sanctions, but the process has accelerated since February 2022. According to statements by Russian elites, more than 90 percent of trade between neighboring countries is now settled in “local currency” – that is, the ruble or the RMB. Most of this is in RMB.

The second way the sanctions on Russia have increased the cross-border use of the RMB is by stoking fears within China’s leadership that Washington will one day use similar measures against Beijing. This has helped move forward to internationalize the “people’s currency” beyond Sino-Russian trade. The growth in cross-border use of the RMB reflects more than just trade with Russia. China is also succeeding in moving away from dollar settlement to RMB with other economic partners, especially in Asia.

Analyze China’s efforts to expand RMB-denominated agreements with Argentina, Mongolia, and Saudi Arabia, and to establish RMB clearinghouses with Brazil, Kazakhstan, and Serbia, among others.

The dollar’s global dominance rests on the central role of the US financial system in the global economy. In all corners of the world, banks that offer cross-border payment services to local customers are connected to major US financial institutions through shared “correspondent accounts.” Viewed from a distance, the dollar system resembles a dense network of ties connecting smaller financial institutions around the world with major US banks at its core. This infrastructure makes using the dollar simple, cheap and attractive compared to alternatives.

For the RMB to play a more important global role, China must build a financial infrastructure that can support the international use of its currency, similar to the dollar system. Before an importer in Kazakhstan can pay for Chinese goods in RMB, banks in Kazakhstan must be connected to financial institutions that provide services in the currency.

Setting up clearing centers abroad is one way to achieve this. Of course, enabling business in RMB does not guarantee that the market will choose to switch from dollars. But expanding the infrastructure is a necessary first step.

Evaluate the key obstacles and opportunities for China’s RMB internationalization efforts.

The list of obstacles is long. Chief among these is hiring an established incumbent. The dominance of the dollar is entrenched. Based on purely economic considerations, China has a difficult task to convince partners to switch from dollars to RMB. The reason we are having this discussion is, of course, that the calculation of which currency to use for cross-border exchange also includes geopolitical considerations. China’s trading partners concerned about ending up on the wrong side of Washington’s foreign policy may see a shift to the RMB as a smart strategic move, even if the economic benefits are not so clear.

Another obstacle to the internationalization of the RMB is the fact that China’s own financial markets remain relatively closed. Foreign companies that earn dollars for exports have an abundance of dollar-denominated assets in which to invest their proceeds. In addition, US financial markets can absorb very large capital inflows, are highly liquid, and investors are confident that their property rights will be protected.

If Beijing really wants to unleash the RMB’s potential, it must liberalize and develop its mainland financial markets in the direction of US markets. China’s leaders have shown little interest in these types of reforms in the past, and there are reasons to be skeptical that this will change any time soon.

Compare and contrast the Chinese CIPS (Cross-border Interbank Payment System) with the international payment system SWIFT.

SWIFT isn’t really the right analogue here. SWIFT is a cross-border payment messaging platform, but it does not move money. It is the industry standard in the way banks communicate with each other; how they request money to be transferred internationally from one account at one bank to another account at another bank abroad. SWIFT is a universal platform, meaning it can be used to request a cross-border transfer of dollars, euros, yen or RMB. Its use as a messaging platform is independent of the currency for which payment is requested.

Funds move through a network of shared ‘correspondent accounts’ between banks. The better analogue for CIPS is CHIPS (Clearing House Interbank Payment System) in the United States. CHIPS is an elite group of US banks that serve as intermediaries for almost all cross-border dollar transactions. These banks are analogous to the small number of major airport hubs that connect hundreds of small airports in the global air transport network.

CIPS is essentially the Chinese version of CHIPS. It is a network of banks in more than 100 countries connected through shared accounts to a small number of elite Chinese banks. These elite Chinese banks act as ‘hubs’ for cross-border RMB transactions, connecting smaller banks in the network, making payments in the currency more efficient.

Assess the global competitive value and reach of the RMB against the USD and the Euro.

It is unfair to suggest that the RMB is a threat to the dollar’s global status. By any measure – foreign exchange reserves, currency transactions, cross-border payments, trade finance – the dollar is miles ahead of the RMB. On no relevant measure is the RMB even close to surpassing the dollar.

The euro is the world’s second most widely used currency by most measures, with one exception: since 2022, the RMB has achieved parity with the euro in the trade finance market. This reflects China’s dominance in global trade and its growing interest in using its own currency for trade settlement.

What is often missed in this discussion is the consideration of what China wants to achieve through the internationalization of the RMB. It is often assumed that China is aiming to overthrow the dominance of the dollar, but there is little evidence that this is the case. It is far more likely that Beijing has a smaller, more achievable goal in mind: reducing China’s dependence on the dollar by increasing the cross-border use of the RMB with its crucial trading partners. This could help reduce China’s vulnerability to financial sanctions such as those imposed by Russia.

In other words, the motives are more defensive than offensive. In my opinion, Beijing has little interest in issuing the world’s most important currency, which carries as much responsibility as it does opportunity.