Hostile future

Look Out: Some Chinese Thinkers Are Girding for a “Financial War”

Behind the good feelings about trade, there are signs China is making plans for a much more hostile future with the U.S.

By JULIAN GEWIRTZ

As the details of a trade deal between the U.S. and China have emerged over the past week, the international community and the business world have reacted with guarded relief. The content is still vague, and there are plenty of quibbles over the particulars, but it appears to have headed off a fresh round of damaging tariffs—and, at minimum, the agreement means that two potentially very serious economic adversaries are still talking.

That relief may be premature. The largest problems facing U.S.-China relations, from emerging technology to the crisis in Hong Kong, remain unresolved. And a careful reading of the conversation inside China suggests that the next front line of the U.S.-China conflict may already be taking shape, with an ominous name: Financial war.

Many members of the Chinese elite, even longtime advocates of market reform and economic opening, see a dark future for U.S.-China relations—and they are increasingly focused on America’s global financial hegemony as a long-term risk for their country. They’re indicating, subtly but unmistakably, that they see global finance as a rising theater of conflict, and are considering new ways for China to defend itself and even to retaliate.

An example is the economist Lou Jiwei, who has long been seen as a liberalizing force in China, an advocate of market reform and international openness. He served as finance minister, ran the country’s massive sovereign wealth fund, and has palled around with western economists since the 1980s. But recently he made a prediction that contained a startling phrase: At a forum in Beijing, according to reporting in the South China Morning Post, he said: “The next step in the frictions between China and the United States is a financial war ( jinrong zhan). The U.S. has been hijacked by nationalism and populism, so will do everything in its power to use bullying measures [and] long-arm jurisdiction.”

In this financial war, he continued, the U.S. will exploit its dominance of the international financial system to hurt China—and China will fight back.

Lou’s comments are just one sign of a significant shift underway in China about the future trajectory of the U.S.-China relationship. Officially, Chinese financial policy remains focused on diffusing domestic risks and increasing inbound investment, and lies in the control of bodies such as the People’s Bank of China and the Ministry of Finance. But shifts in how China’s rulers are thinking about policy are often signaled in the language used by former top officials and government-linked experts.

Chinese concerns about American financial power have risen throughout 2019 and intensified dramatically in recent months. The high-profile arrest of Huawei executive Meng Wanzhou reportedly relied on cooperation from U.S. banking institutions to demonstrate that Huawei had violated sanctions on Iran—triggering a fierce response from Beijing, which decried these actions as “motivated by strong political intentions and manipulation.” After the U.S. officially labelled China a currency manipulator in August 2019, both Zhou Xiaochuan, the longtime central bank governor, and Chen Yuan, a former central bank deputy governor and Communist Party princeling, called for China to find new ways to use the yuan instead of the dollar in many more international transactions.

Zhou Yu, director of international finance research at the government-run Shanghai Academy of Social Sciences, recently also predicted an escalating “financial war,” ringing the alarm that China should see the “urgency of beefing up its financial independence and sovereignty.”

And Huang Qifan, a prominent retired economic official and former mayor of the megacity Chongqing, in September decried the U.S. acting as “the world’s boss for decades,” using “long-armed jurisdiction” in economic and legal domains to commit acts of “unreasonable bullying.” (The language closely echoed that of Lou in his remarks in Beijing.) Earlier this month Huang called again for China to fortify its defenses.

There are plenty of reasons to think a financial war won’t get hot anytime soon; the barriers to upheaval are daunting because of the dominance of the dollar and China’s reliance on foreign capital, among other reasons. But U.S. leaders need to pay attention even so. For many years, such harsh and open denunciations of the global financial system were primarily the purview of nationalistic writers such as People’s Liberation Army officer Qiao Liang, who has condemned the American “financial empire” while writing anti-American screeds. The fact that even these more mainstream voices are joining the chorus is a significant and underexamined shift, and one likely to matter far beyond the current trade deal.

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This is not the relationship the Trump administration seems to have expected. The going theory in the White House, articulated most frequently by the hawkish trade advisor Robert Lighthizer as well as influential China advisor Michael Pillsbury and former National Economic Council deputy director Clete Willems, is that Chinese “ reformers” would gain the upper hand if the U.S. applied enough pressure.

This theory always relied on a measure of wishful thinking, especially in an era of extraordinarily centralized power under Xi Jinping, and Lou’s comments should put a nail in that coffin. Even longtime Chinese “reformers” are beginning to see economic integration with the U.S. as a source of enormous vulnerability.

Rather than praising international integration, they are promoting China’s way of governing its economy, specifically the controls it maintains on its financial system, as sources of stability and strength. Internationalizing China’s currency and moving towards full capital account convertibility are longtime goals of many Chinese internationalists—but, Lou said pointedly, these are “not safe options” in this new world of financial war.

What would a “financial war” with China actually look like? One target of Chinese concern is the U.S.-dominated infrastructure of the financial world. Most of the world’s currency reserves are held in dollars, and the dollar remains indispensable in international trade and transactions. The historian Adam Tooze has called this “the hegemony of the dollar-Treasury nexus in global finance.” As a result, even across Xi Jinping’s trademark Belt and Road Initiative, contracts are undertaken in U.S. dollars.

A very specific piece of infrastructure that concerns China is the Society for Worldwide Interbank Financial Telecommunication (SWIFT), the international financial messaging system used widely for cross-border payments. It’s based in Belgium and claims to be “a global and neutral service provider,” but because of the massive power of the United States, it has complied with U.S. sanctions (such as sanctions to shut out Iranian banks) even over the objections of the European Union. This makes it a very effective tool of U.S. influence over global financial markets.

Lou, in his remarks, called for China and other countries to create “independent international clearance systems” that would weaken American leverage over their economies. In late October, the nationalist tabloid Global Times praised joint efforts by China, India, and Russia to create an alternative to SWIFT. Huang Qifan, the retired economic official, has criticized SWIFT and other similar systems.

It’s not clear that China would be able to develop a real alternative anytime soon: China started its own Cross-border Interbank Payment System in 2015, but it has not gained traction, and some Chinese academics have acknowledged that replacing SWIFT may be “utterly impossible.” Yet China’s leadership increasingly seems determined to try to engineer alternatives to U.S. dominance of international finance. Some of its strategies may seem quixotic, such as Xi Jinping’s recent endorsement of blockchain technologies, which he sees not just as a promising technology, but also a tool to someday diminish the power of the dollar.

Other strategies will involve more direct challenges to the U.S.-dominated financial order—either through partnerships with countries that also seek alternatives to the order, such as Russia, or using China’s own economic leverage to apply coercive pressure. Xi Jinping’s China is increasingly comfortable using access to its colossal economy to intimidate others and get its way, as the National Basketball Association recently discovered. It may use similar pressure points—targeting U.S. firms or even individuals—if a financial war escalates.

The coming months will test whether Beijing does in fact pursue new ways of challenging the dollar. The prospect is daunting: China accounted for more than 25 percent of global GDP growth in 2018, but its currency still makes up less than 2 percent of all assets held by central banks and only 1 percent of the international payments market. This is amplified by the fragility of the Chinese economy and especially the tremendous systemic risk, bad debt and other problems that plague China’s financial sector, which Chinese Communist Party general secretary Xi Jinping has declared one of his top priorities.

Indeed, despite concerns about U.S. financial power, recent reform measures have sought to bring more foreign capital into the country while still controlling money leaving the country. This is partly because China’s balance of payments position is no longer as robust as it once was and because it needs to finance debt servicing on dollar-denominated debts.

Faced with such limited options, Chen Yuan even raised the prospect of China using its biggest potential source of leverage : Its holdings of U.S. sovereign debt, which total $1.1 trillion. “That means the U.S. is not completely without weakness,” he said. But weaponizing Chinese holdings of U.S. sovereign debt would have catastrophic effects on China as well as on the U.S.—it’s the financial equivalent of a nuclear attack.

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As those issues suggest, both China and the U.S. would have a lot to lose in any financial war, and it’s important not to overstate how likely it is to happen soon. Given the scale of the financial interconnections, conflict in this domain is much more likely to play out incrementally rather than in a sudden, catastrophic attempt at disintegration.

But even short of an all-out conflict, the shifting opinion among Chinese elites has a real importance for American leaders to understand: It speaks to the risks, as well as the benefits, of a mutual economic dependency. The political scientists Henry Farrell and Abraham Newman coined the term “ weaponized interdependence” to describe this risk. For many years, the dominant view in both capitals was that integration and interdependence brought benefits to both countries, along with manageable risks and downsides. Now the Trump and Xi administrations seem to have endorsed the other extreme: that interdependence creates frightening vulnerabilities and unacceptable weakness—and new leverage points in an already fraught geopolitical rivalry. Many people in both countries, even longtime reformers like Lou Jiwei, are starting to agree.

This challenge is playing out as the Trump administration and Congress consider measures that would mark a significant escalation in the emerging “financial war.” These include attempts to restrain foreign purchases of U.S. financial products and assets by imposing a “market access charge,” long-overdue requirements that companies listed on U.S. exchanges comply fully with auditing standards, limiting portfolio flows into China, and even delisting Chinese firms from U.S. exchanges.

When considering any of these steps, U.S. policymakers need to anticipate not simply the immediate Chinese reaction but also map out the longer-term consequences. Simply put, they must decide whether it is really in the U.S. interest to drive China to search more aggressively for ways to subvert or escape the U.S.-dominated financial system—even if China would struggle mightily to do so.

For European leaders, a U.S.-China “financial war” would risk significant collateral damage, as the global financial architecture into which Europe is deeply integrated comes under severe strain. To be sure, near-term opportunities also exist for Europe: this emerging dimension to the U.S.-China conflict could push China to lean more heavily on European capital markets. But if the conflict escalates—and, for example, the Trump administration considers secondary sanctions on any firm that does business with Chinese entities that the U.S. seeks to exclude from international finance—European leaders will find it difficult to avoid taking sides.

A U.S.-China financial war fundamentally would be a contest over the ability of the United States to use its centrality in global finance to exert its power over its competitors and adversaries faster than they can find alternatives. The U.S. remains profoundly dominant, and China has few viable options—at least, not today. But if China undertakes a long-term struggle to develop alternative networks and succeeds in doing so, the impact on the foundations of American power would be severe. A real shakeup in the financial order would be far beyond
anything a trade agreement could fix. That future may be distant, but it is no longer unthinkable.