China is defending against the dollar’s dominance

The country is implementing defensive economic strategies, at least for now

Financial security has become an indispensable part of China’s national security discourse since the 1997 Asian financial crisis. Rising geopolitical tensions with the US since 2018 and the West’s financial sanctions against Russia have further incentivised Chinese policy-makers to fortify the economy by diluting the dollar’s centrality and developing an alternative system. To this end, the Chinese government has pursued three primary strategies.

First, China has supported and promoted regional and multilateral currency and financial co-operation through regional or non-western partnerships. In 2000, it supported the launch of the Chiang Mai Initiative in the aftermath of the Asian financial crisis and the Bank for International Settlements’ Renminbi Regional Liquidity Arrangement in 2022 in response to the economic shocks of the Covid-19 pandemic. The Chinese government has also engaged with the Shanghai Cooperation Organisation and the other Brics member countries (Brazil, Russia, India and South Africa) to promote using local currencies in trade, investment and development finance.

Second, China has attempted to broaden the use of the renminbi in international trade and investment while promoting renminbi-based international financial infrastructures. Since the 2008 financial crisis, the Chinese government has put resources into developing a renminbi-based financial infrastructure.

In 2015, it launched the Shanghai-based Cross-border Interbank Payment System as a critical piece of financial infrastructure to promote renminbi internationalisation. CIPS allows banks to clear cross-border renminbi transactions onshore instead of through offshore renminbi clearing banks, providing a one-stop alternative to a combination of the Swift messaging system and the New York-based Clearing House Interbank Payments System. CIPS was seen as China’s alternative to the dollar-based financial infrastructure even before Russian banks were excluded from Swift in 2022. In this regard, CIPS is a proprietary financial infrastructure that can allow sanctioned entities to access global markets, although dodging sanctions was not the original motivation for its introduction.

Third, China aims to improve the renminbi’s role in global commodities pricing, especially in the transition to clean energy. China has developed several commodities trading platforms, such as the renminbi-denominated futures market and the commodity exchanges. China launched renminbi-denominated oil futures in 2018 and copper futures in 2020 on the Shanghai International Energy Exchange. It also launched the Ganzhou Rare Metal Exchange in 2019, in which the Chinese currency is used to quote prices for spot trading of tungsten, rare earth products and critical minerals (like cobalt) that are essential to the clean energy transition.

In the near to medium term, China can capitalise on the energy transition to cultivate a ‘gas-yuan’, emulating the petrodollar. As the global economy transitions from hydrocarbon-dependent to mineral-dependent, China could also leverage its dominance in critical mineral supply chains and its partnership with mineral-rich countries.

China’s strategies to develop an alternative financial system are defensive rather than offensive – at least for now. The goal is to minimise the negative consequences of the West’s comprehensive sanctions against China in extreme geopolitical scenarios such as a military conflict over Taiwan. Expanding the use of the renminbi in trade is less challenging than increasing its status as an international reserve currency.

Capital controls are not necessarily a dealbreaker for the broader adoption of the renminbi in trade, as China is already a top trading partner for over 120 countries, and the Chinese government is willing to facilitate exports by offering currency swaps and providing trade finance. However, capital controls, combined with the lack of risk-free renminbi-denominated assets, the relatively closed nature of the Chinese financial market, President Xi Jinping’s preference for the rule of one man over the rule of law and the erosion of market principles further obstruct the renminbi’s rise as an international reserve currency that can credibly challenge the dollar.

Zongyuan Zoe Liu is Maurice R Greenberg Fellow for China Studies, Council on Foreign Relations.

This article will be published in OMFIF’s forthcoming Global Public Investor 2024. Zoe will be joining us at the launch on 4 June to discuss the key themes from the report. Register to attend now.

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