Even as China grows in economic and military power, perhaps nothing reveals Beijing’s weaknesses more than the US’ control of the global financial system.
China has sought ways to counteract US sanctions after the administration of former US president Donald Trump targeted Chinese officials and companies over policies from the South China Sea to Xinjiang.
Hong Kong’s leader cannot access a bank account and a top executive at Huawei Technologies Co is detained in Canada.
Even China’s state-run banks are complying with US sanctions.
That is one reason that the administration of US President Joe Biden is starting to study whether China’s development of a digital currency will make it harder for the US to enforce sanctions.
The digital yuan, which could see a wider rollout at next year’s Beijing Winter Olympic Games, is also spurring the US to consider creating a digital dollar.
However, instead of challenging US dollar dominance and neutralizing sanctions, the digital yuan appears potentially more geopolitically significant as leverage over multinational companies and governments that want access to China’s 1.4 billion consumers.
As China has the ability to monitor transactions involving its digital currency, it might be easier to retaliate against anyone who rebuffs Beijing on sensitive issues like Taiwan, Xinjiang and Hong Kong.
“If you think that the United States has a lot of power through our Treasury sanctions authorities, you ain’t seen nothing yet,” Matt Pottinger, a former US deputy national security adviser in the Trump administration, told a hearing of the US government-backed US-China Economic and Security Review Commission last week. “That currency can be turned off like a light switch.”
So far, China has mostly resisted hitting foreign firms in response to US actions on companies like Huawei, holding off on releasing an “unreliable entity list” designed to punish anyone who damages national security.
Any move to cut off access to the digital yuan would carry similarly high stakes, potentially prompting foreign investors to pack up and leave.
However, Beijing has gone after brands like H&M for statements on human rights issues, even while Chinese government officials have been careful to avoid directly endorsing a boycott.
Last month, the Chinese Communist Party (CCP) Youth League on a Chinese microblogging site declared: “Want to make money in China while spreading false rumors and boycotting Xinjiang cotton? Wishful thinking!”
Controlling access to China’s massive market remains the best way for Beijing to hit back at the US: As long as Chinese companies still want access to the broader financial world dominated by the US and its allies, Washington can effectively wield sanctions against nearly anyone who does not operate exclusively in China’s orbit — and Beijing has little incentive to shun the US dollar.
While Chinese President Xi Jinping (習近平) has called for greater self-sufficiency in key technologies like advanced computer chips, a financial decoupling from the US would only hurt China’s economy and potentially leave the CCP more exposed to destabilizing attacks.
After Xi last year effectively ended Hong Kong’s autonomy with a sweeping National Security Law, Washington refrained from cutting off the territory’s ability to access US dollars due to the potential devastation to the global financial system.
Widespread use of the digital yuan could potentially give the Chinese central bank more data on financial transactions than big technology companies, allowing the CCP to strengthen its grip on power and fine-tune policies to bolster the economy.
While that level of control might boost growth in the world’s second-biggest economy, it also risks spooking companies and governments already wary of China’s track record on intellectual property rights, economic coercion and rule of law.
China’s state-endorsed boycott of H&M shows “great commercial risk” for companies that use the digital yuan, Yaya Fanusie, a fellow at the Center for a New American Security in Washington, told the US-China commission hearing.
If foreign merchants had to use the digital yuan, Beijing could prohibit transactions with H&M wallets, and the store could disappear from digital yuan apps, he added.
“This is the other side of the coin — Beijing not as a sanctions evader, but more empowered to enforce its own financial muscle,” said Fanusie, who has written extensively on how central bank digital assets might affect US financial sanctions. “China’s digital currency is as much about data as it is about money.”
Foreign firms that use the digital yuan “might end up handing over to the Chinese government lots of real-time data that it could not access efficiently through conventional banking technology,” he said.
China’s ability to see every transaction might make it difficult for foreign banks to use the digital yuan and still comply with confidentiality rules in their home countries, said Emily Jin, a research assistant at the Center for a New American Security.
However, the currency might appeal to some regimes that prioritize control over privacy protection, Jin said.
“They might find it easier to convince governments more authoritarian in their leaning that it helps monitor elicit activities, or stop them quickly, or stop them before they happen,” Jin said. “They aren’t going to market it to everyone.”
The digital yuan would serve as a backup to Ant Group’s Alipay and Tencent’s WeChat Pay, which together make up 98 percent of China’s mobile-payments market, People’s Bank of China (PBOC) Digital Currency Research Institute director Mu Changchun (穆長春) said last month.
The digital yuan had the “highest level of privacy protection,” he said, adding that the central bank would not directly know the identity of users, but Beijing could get that information from financial institutions in cases of suspected illegal activity.
Chinese policymakers have repeatedly emphasized that the digital yuan is not meant to challenge the US dollar, with PBOC Deputy Governor Li Bo (李波) last week saying that the motivation for the digital currency is primarily for domestic use.
Former PBOC governor Zhou Xiaochuan (周小川) on Wednesday downplayed the risks of the technology to the global financial system at the Boao Forum, saying that the digital yuan would mainly be used for small retail payments.
The Chinese currency makes up about 2 percent of global foreign exchange reserves, compared with nearly 60 percent for the US dollar, and most of Beijing’s trade and loans under the Belt and Road Initiative are disbursed in US dollars.
Any serious challenge to the US dollar’s position as the world’s reserve currency would also require significant policy changes from China, including lifting capital controls that help the CCP keep a lid on sudden outflows that could trigger a financial crisis.
Even if the digital yuan could be transacted more cheaply outside of US-controlled global payment systems, it is unclear if anyone would use it.
“The dollar is not the dominant reserve currency because the Americans say it must be,” said Michael Pettis, a professor at Peking University and fellow at the Carnegie-Tsinghua Center for Global Policy in Beijing. “The dollar is the dominant reserve currency because the Chinese, the Europeans, the Japanese, the South Koreans etc. say it must be. It’s the rest of the world that imposes that because they think its the safest place to park money.”
The US still has an incentive to set standards for digital currencies. In a survey last year of 65 central banks representing 91 percent of global economic output, the Bank of International Settlements found that more than half were experimenting with digital currencies and 14 percent were moving forward to pilots.
The US itself is taking a cautious approach: US Federal Reserve Chairman Jerome Powell last month said that policymakers must understand the costs and benefits of a digital US dollar, and would not rush the “very, very large, complex project.”
China in 2014 began research on the digital yuan, right after the price of bitcoin surged from US$13.40 to more than US$1,000, raising the risk that digital currencies could affect Beijing’s control of monetary policy.
It has begun technical testing with Hong Kong for cross-border payments, and is working with Thailand and the United Arab Emirates on real-time foreign exchange settlements. Authorities are also studying how the digital yuan can be combined with 5G networks and the Internet of Things.
This kind of research allows China a greater say in how other countries across the globe design digital currencies, particularly when it comes to questions of surveillance, privacy and anonymity, Atlantic Council Geoeconomics Center director Josh Lipsky said.
“China is really leading in this area, and it should be a wake-up call to the US and to Europe,” Lipsky said. “There is a serious first mover advantage, not because of what China will do, but what other countries are doing.”
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