Escalating China-US confrontation will accelerate RMB internationalisation

In an opinion piece for Fox News on 25 June, Republican member of the US House of Representatives Ann Wagner wrote that due to the attempted cover-up of the origin of Covid-19 by the Communist Party of China (CCP), she had tried to initiate the Compensation for Americans Act aimed at imposing sanctions on CPC officials and freezing Chinese assets in the US.

Although the bill was blocked by the Democratic Party during the discussion in the US Congress, the specific measures proposed by Wagner in the bill deserve special attention. They include freezing the necessary Chinese assets in the US in order to reach a bilateral compensation agreement with China, removing China's eligibility for World Bank development loans, removing China's "developing country" status in international bodies, and prohibiting the use of federal retirement savings for investing in China.

With the growing tension between China and the US, the imposition of financial sanctions by the US on China has already become a hot topic, on which the US has not yet reached a clear consensus. In early January this year, US thinktank Peterson Institute for International Economics (PIIE) published a policy brief entitled "Raising A Caution Flag On US Financial Sanctions Against China", reminding the Biden administration to exercise caution on new financial restrictions against China. Within half a year, a US Representative is trying to introduce legislation to impose new financial sanctions against China. This demonstrates that the hawkish US politicians are raring to go.

In fact, the US has long started to impose financial sanctions with limited effect on Chinese enterprises and individuals, due to issues on Xinjiang, Hong Kong and Iran. The question is when will the list of sanctions targets be further expanded and new measures of financial sanctions imposed? And the next question will be China's response, especially since there would be immediate pressure on the renminbi (RMB). If the worst-case scenario happens, such as prohibiting Chinese state-owned banks from using the USD, can the RMB and its currency support fulfil the full functions of an international currency for the effective operation of China's economy? This is related to the medium- and long-term goals of the RMB internationalisation strategy.

According to the PIIE, the US has been using economic sanctions to pressure its opponents in the past decades, and this has intensified during the Obama and Trump administrations. The US has mainly used trade sanctions in the past but has increasingly adopted financial sanctions against Iran and Russia in recent years. Financial sanctions include, but are not limited to, freezing the assets of enterprises or individuals in the US, prohibiting assistance and stopping international financial institutions from lending to those sanctioned, as well as prohibiting US financial enterprises from trading with them. US financial sanctions are imposed mainly via the Specially Designated Nationals and Blocked Persons List (SDN).

Recently, the total number of sanctions targets related to China and Hong Kong ranked seventh and tenth respectively on the SDN. Among these, a typical case of a sanctioned Chinese financial institution is the Bank of Kunlun Corporation Limited, due to it having provided significant financial services or facilitated significant transactions to many sanctioned Iranian banks, the details of which are excluded here as they have been extensively analysed in China and overseas.

A typical sanctioned individual is Hong Kong Chief Executive Carrie Lam. Pursuant to US Executive Order No. 13936 that imposes sanctions on the relevant personnel who participated in the formulation of the Hong Kong National Security Law, Lam was sanctioned on 7 August 2020. She said in a subsequent interview that no bank could provide banking services to her as the Hong Kong chief executive, that the Hong Kong government could only pay her salary in cash, and she could only make purchases in cash. On 5 June this year, Lam predicted during a meeting with the media that she would be sanctioned by the US for the rest of her life, as the experience of US-sanctioned Iranian officials has shown that sanctions against individuals will continue even after they have left office.

The financial and monetary might of the US stems from its financial strength, its hegemony with the USD as the leading international currency, and the asymmetric interdependence between other nations and the US. Simply put, there are three options to avoid sanctions. Firstly, nations can be obedient to the US. Secondly, they can endeavour as far as possible to achieve financial and monetary decoupling from the US, as in the cases of Russia and Iran. Thirdly, nations can build up their financial and monetary strengths to compete with the US and the USD, just as there will be no large-scale war among nations with nuclear weapons.

How likely will the US impose more extensive and impactful financial sanctions on China in the future? I believe that the possibility is moderate or more than half. This can be analysed through the three dimensions of opportunity, geopolitics, and leadership.

Opportunity encompasses megatrends, including factors such as Covid-19 that have caused global divisions. The change in emphasis of China's economy from the "great international circulation" strategy to "dual circulation" prioritising domestic consumption appears to be an adjustment in response to this. As China becomes the number one competitor and a major threat to the US, the US will deal with China the way it has dealt with its other competitors, that is to slowly isolate China through decoupling. Financial and monetary decoupling may be the checkmate.

Geopolitics includes specific issues such as those related to Taiwan, Hong Kong, Xinjiang, the South China Sea, and Covid-19's origin, which are potential reasons for US sanctions. PIIE's policy brief clearly states that the US Treasury should "avoid designating G-SIBs [global systematically important banks] and other high-profile entities without a full analysis and clear understanding of the potential consequences for US interests and international financial markets". Currently, out of the 30 G-SIBs, four are Chinese banks (Bank of China, Agricultural Bank of China, Industrial and Commercial Bank of China, and China Construction Bank). I guess the unstated portion of that statement is "if necessary, first analyse and clearly understand the potential consequences, and designate the four important Chinese banks in the SDN if need be".

Leadership refers to the leader of the US. Black swan events will frequently occur if "political amateurs", like Trump, ascend to power again, bringing great uncertainty. There is no guarantee that the US presidents after Biden will not adopt Trump's style of "considering himself the winner as long as the opponent loses more", and like the trade war, wage financial and currency wars against China.

China's response is of course to accelerate RMB internationalisation. However, Chinese officials have never set specific goals for RMB internationalisation. US monetary and political scholar Benjamin Cohen believes that this demonstrates China's lack of a clear RMB internationalisation strategy. In recent years, there are increasing analyses, discussions and predictions on the need to set goals and what constitutes feasible goals.

Wang Yongli, former vice-president of the Bank of China, proposed in early 2021 that the long-term goal of RMB internationalisation is more than 20% share of international clearing and settlement, and around 30% share of global reserves. He also added that the ten-year goal by 2029, the second decade of RMB internationalisation, should be for the RMB to exceed 10% market share of international currencies, and this is consistent with the 10.92% currency weight envisaged when the RMB was formally included in the IMF's Special Drawing Rights basket of currencies in 2016.

Chinese scholars Zhang Ming and Wang Zhe believe that as long as China's economy maintains moderate to high growth and China's financial market enhances its broadening, deepening and liquidity, China can avoid systemic financial crises. Between 2030 to 2035, the RMB is expected to surpass the British pound sterling (GBP) and the Japanese yen (JPY) as the payment, trading, and reserve currency, to become the third largest international currency after the USD and the euro.

Combining the above yields two conclusions. Firstly, 2029-2030 will be a critical point in time. Secondly, the RMB can almost surpass the GBP and the JYP by then. However, I beg to differ, especially considering the comprehensive, strategic China-US competition.

Firstly, the pace of RMB internationalisation is determined by the pace of the development of the China-US competition towards confrontation. If the competitive momentum exceeds that of confrontation, RMB internationalisation will continue slowly and maintain its current pace (and the RMB surpassing the GBP and the JPY in 2039-2040 is predicted). In the opposite scenario, RMB internationalisation will accelerate (and the RMB surpassing either the GBP or the JPY before 2029 is predicted).

Against the backdrop of impending China-US confrontation, China and Iran signed a 25-year cooperation agreement on 27 March this year. According to international media, this agreement will enable China to purchase Iranian oil with the RMB. Using the RMB to price and settle payments for oil will have a direct impact on the monopoly of the USD in oil trading. Once the US commences a wider range and stronger financial sanctions against China, RMB internationalisation will definitely accelerate.

Secondly, the financial and monetary interdependence between China and the US acts as the most important "stabiliser" of China-US relations. If the US uses its financial power (to cut off financing channels) and monetary power (to prohibit China from using the USD) to sanction and suppress China, China will certainly retaliate, with a high probability of selling large quantities of USD assets and prohibiting the use of the USD in foreign trade. Without the largest USD user, the USD market share will inevitably plunge, thus increasing the RMB's share.

However, the critical issue is whether RMB internationalisation really meets the needs of China's political stability and economic development. China's core concern is domestic, aiming to ensure domestic financial stability and the stability of the RMB exchange rate, which will result in strict capital controls and huge foreign exchange reserves in the USD. The US's core concern is global, which aims to ensure global capital flow mainly in the USD, resulting in global financial instability and huge debts. As long as this situation persists, the status of the RMB and USD will fundamentally not change.

Another issue for discussion is whether reserve, pricing or settlement currency is a better indicator for the strength and status of an international currency. While this issue is still debatable in academia, the basic consensus is that all three indicators are very important. If one of the three must be chosen, then the majority believes that it is reserve currency. According to the latest IMF data on 30 June, the USD's share of currency reserves reported to the IMF edged up to 59.5% or US$6.99 trillion in the first quarter of the year, from 58.9% in the previous quarter. The RMB's share increased to 2.4% or US$287 billion in the same quarter, from 2.2% in the previous quarter.

Taking a longer view, the USD share of global reserves peaked at 72.7% in the second quarter of 2001 and has continued to slip since then. One very important reason for this is the emergence of the euro. The euro was once considered as an international currency that could challenge the status of the USD. Since its official circulation in 1999, its share in global foreign reserves reached its peak of 28% in 2009 but has dropped to 20.6% in the first quarter of this year. This also means that the euro has failed in its competition with the USD as the reserve currency and has not managed to take over the share of USD held by China, Japan, and other major reserve countries.

For the RMB, the 2.4% share it has achieved appears underwhelming after 12 years of internationalisation. However, when taken with the view that RMB internationalisation has taken place under strict capital controls, this achievement is a miracle instead. However, in the long run, to attain 30% share of global reserves, China must solve the problem of capital controls.

Indeed, the current level of RMB internationalisation meets China's previous needs in economic development. With changes in the external environment, however, the US is gearing up to impose financial sanctions on China. It remains to be seen whether it is timely to accelerate RMB internationalisation.

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