Will China Be Locked Out of the Global Financial System?

August 15, 2020 Updated: August 18, 2020

News Analysis

Experts inside China are increasingly sounding the alarm regarding potential U.S. sanctions that could cut off Chinese financial institutions from the global financial system.

President Donald Trump has taken a harder line against the Chinese Communist Party (CCP) in recent months. In response to the regime’s subversion of Hong Kong’s autonomy, Trump has ended the city’s special economic privileges with the United States, signed the Hong Kong Autonomy Act—which sanctions individuals and entities involved in the recent erosion of Hong Kong’s democracy—into law, and sanctioned the city’s leader, Carrie Lam, and 10 other Chinese and Hong Kong officials involved in undermining the territory’s freedoms. 

Even amid escalating tensions between the world’s two largest economies, a full financial “decoupling”—which would effectively lock Chinese financial institutions out of the global U.S. dollar settlement system—seems improbable.

But sanctions on Chinese social media apps TikTok and WeChat also seemed unlikely just a few months ago. 

The financial decoupling threat is real, and its severe consequences are causing the CCP and Chinese financial sector to examine their options.

Locked Out

A full financial war could lock Chinese banks out of the dollar system, which the majority of global trade is based upon. The Trump administration could sanction Chinese banks, financial institutions, and even seize Chinese-owned assets in the United States.

What does that mean and why is that significant?

A bank’s lifeblood is monetary transactions. Most international cross-border transactions are conducted in U.S. dollars. International bank transfers settling in U.S. dollars mostly use the SWIFT system, a messaging language used since the 1970s by global banks to instruct payments. Around 11,000 banks around the world use SWIFT to transact 38 million times per day, according to the SWIFT website.

If Chinese financial institutions are sanctioned by the United States, SWIFT could exclude such companies from utilizing the messaging system, which could lock the CCP out of settling U.S. dollar transactions anywhere in the world. 

While SWIFT is based in Belgium and is subject to European Union laws, it has precedence in excluding institutions subject to U.S. sanction laws (e.g., North Korea). And the main transaction methods within the U.S.—Fedwire and CHIPS—would also be unavailable to Chinese institutions.

In a full financial war, the United States could also freeze assets of sanctioned entities and individuals, denying them access to assets domiciled domestically. Hundreds of billions of dollars worth of China-owned assets such as bank accounts, investments, and real estate would effectively be frozen.

Chinese investment in the United States exceeded $180 billion from 2005 to the end of 2019, according to data from the American Enterprise Institute.

RMB Adoption Declining

“Chinese financial institutions and regulators should fully assess the potential risk of being cut off from SWIFT,” Shi Jiayou, a professor at Renmin University of China, wrote in an op-ed in Caixin, a mainland business magazine. “Instead of blindly hoping for the best, China should plan ahead.”

One of the contingencies Beijing has been planning for since the early 2000s is internationalization of its currency, the yuan. Despite continued efforts such as launching yuan-denominated overseas bonds, establishing yuan exchange linkages, and the One Belt, One Road infrastructure investment initiative, very little progress has been made in the international usage of the yuan during the last few years.

International adoption of the yuan has actually declined over the past five years. Standard Chartered Bank’s Renminbi Globalization Index, which has measured the internationalization of the yuan since 2011, plateaued in November 2015 with a reading of 2,563. In the latest reading, as of March, offshore yuan usage rate was pegged at 2,224. Standard Chartered, a leading bank in the Asia-Pacific region, is thought to have the most comprehensive data on offshore yuan.

More recently, Beijing has partnered with Moscow to reduce dependence from the U.S. dollar’s global hegemony. U.S. dollar usage in bilateral trade between Russia and China fell below 50 percent for the first time in the first quarter of 2020.

Officially, the dollar was used to settle 46 percent of Russian–Chinese transactions, the euro was used 30 percent, while trade settlement using the ruble and the yuan combined made up 24 percent of transactions, according to Russian government data cited by the Nikkei Asian Review.

While the dollar usage metric still seems high, given China and Russia’s long intent to “de-dollarize,” Moscow and Beijing still hailed it as a “breakthrough moment,” in the words of Alexey Maslow of the Russian Academy of Sciences, according to the Nikkei report.