The Diplomat author Mercy Kuo regularly engages subject-matter experts, policy practitioners, and strategic thinkers across the globe 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, Atlantic Council senior fellow, and author of “Bucking the Buck: U.S. 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 U.S. sanctions against Russia boosted cross-border use of China’s currency, the renminbi (RMB).
Two ways. First, by growing the use of the RMB in cross-border trade settlement directly between China and Russia. U.S. financial sanctions cut targeted actors off from using the dollar system, which forces targets into alternative currencies that are exchanged outside of the U.S. financial system. Beijing and Moscow were already working on de-dollarizing their bilateral trade prior to the war in Ukraine following years of escalating U.S. sanctions, but the process has sped up since February 2022. According to statements from Russian elites, more than 90 percent of trade between neighboring powers is now settled in “local currencies” – meaning the ruble or the RMB. The bulk of this is in RMB.
The second way that sanctions against Russia have increased the RMB’s cross-border use is by fueling fears within China’s leadership that Washington will one day use similar measures against Beijing. This has helped to propel forward moves to internationalize “the people’s currency” beyond Sino-Russian trade. Growth in the RMB’s cross-border use reflects more than trade with Russia. China is also succeeding in transitioning away from settlement in dollars into RMB with other economic partners, predominantly in Asia.
Analyze China’s efforts to expand RMB-denominated deals with Argentina, Mongolia, and Saudi Arabia, and establish RMB clearing-houses with Brazil, Kazakhstan, and Serbia, among others.
The dollar’s global dominance rests on the centrality of the U.S. financial system in the world economy. In every corner of the world, banks providing cross-border payment services to local clients are connected to major U.S. financial institutions through shared “correspondent” accounts. Viewed from a distance, the dollar system looks like a dense network of ties connecting smaller financial institutions around the world with big U.S.-based banks at the core. This infrastructure makes using the dollar easy, cheap, and attractive relative to alternatives.
For the RMB to take on a more significant global role, China needs to build a financial infrastructure capable of supporting its currency’s international use akin to the dollar system. Before an importer in Kazakhstan can pay for Chinese goods in RMB, banks in Kazakhstan need to be connected to financial institutions that provide services in the currency.
Establishing clearing centers abroad is one way to accomplish this. Of course, making it possible to conduct business in RMB does not guarantee that the market will choose to make the switch away from dollars. But building out the infrastructure is a necessary first step.
Evaluate key obstacles and opportunities to China’s RMB internationalization efforts.
The list of obstacles is long. Chief among these is taking on an established incumbent. The dollar’s dominance is entrenched. Based on purely economic considerations, China has a difficult task in convincing partners to switch from dollars to RMB. Of course, the reason we are having this discussion is because the calculus regarding which currency to use for cross-border exchange includes geopolitical considerations as well. China’s trade partners worried about ending up on the wrong side of Washington’s foreign policy may view a shift into the RMB as a smart strategic move even if the economic benefits are not so clear.
Another obstacle to RMB internationalization is the fact that China’s own financial markets remain quite closed. Foreign firms earning dollars for exports have a plethora of dollar-denominated assets in which they can invest their receipts. Furthermore, U.S. financial markets can absorb very large capital inflows, they are highly liquid, and investors are confident that their property rights will be protected.
For Beijing to truly unleash the RMB’s potential, it needs to liberalize and develop its mainland financial markets in the direction of U.S. markets. China’s leadership has shown little appetite for this type of reform in the past, and there are reasons to be skeptical this will change soon.
Compare and contrast China’s CIPS (Cross-border Interbank Payment System) with the international payment system SWIFT.
SWIFT is not really the right analog here. SWIFT is a cross-border payment messaging platform, but it does not move funds. It is the industry standard in how banks communicate with one another; how they request that funds be moved, internationally, from one account at one bank to another account at a different bank in a foreign country. 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 being requested for payment.
Funds are moved via a network of shared “correspondent” accounts between banks. The better analog for CIPS is CHIPS (Clearing House Interbank Payment System) in the United States. CHIPS is an elite group of banks in the U.S. that serve as the middlemen for nearly all cross-border dollar transactions. These banks are analogous to the small number of major airport hubs connecting hundreds of small airports with one another in the global air transportation network.
CIPS is essentially China’s version CHIPS. It’s a network of banks in over 100 countries that are connected via shared accounts to a small number of elite Chinese banks. These elite Chinese banks operate as the “hubs” for cross-border RMB transactions, connecting smaller banks in the network, making payment in the currency more efficient.
Assess the global competitive value and reach of the RMB vis-à-vis the USD and euro.
It is disingenuous to suggest that the RMB is a threat to the dollar’s global status. By any measure – foreign exchange reserves, FX trades, cross-border payments, trade finance – the dollar is miles ahead of the RMB. On no relevant metric is the RMB even close to surpassing the dollar.
The euro is the world’s second most widely used currency by most metrics with one exception: since 2022, the RMB has reached parity with the euro in the trade finance market. This reflects China’s dominance in global commerce and its growing interest in using its own currency for trade settlement.
What is often missed in this discussion is consideration of what China wants to achieve through RMB internationalization. It is often assumed that China is aiming to topple dollar dominance, but there is little evidence to suggest 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 growing the cross-border use of the RMB with its critical trade partners. Doing so can help to reduce China’s vulnerability to Russia-style financial sanctions.
The motives, in other words, are defensive rather than offensive. In my view, Beijing has little interest in issuing the world’s key currency, which comes with as much responsibility as it does opportunity.